Thursday, June 14, 2012

Economic epidemiology Predicting financial contagion

June 16, 2012

Can Greece leave the euro quietly? Its size would suggest so: the Greek economy is just 2% of the euro area’s GDP. But so far the Greek crisis has had plenty of noisy knock-on effects. Economists, who like to borrow medical terms to lend themselves an air of scientific rigour, call this “contagion” (see also: Dutch disease, liquidity injection, etc). Economic troubles in one country can infect others. Can economic epidemiology predict which countries might fall sick following a Greek exit?

It has long been known that shocks in large countries or markets send out ripples. In a 1989 paper Robert Shiller of Yale University showed that between 1919 and 1987 American and British stockmarkets had moved in tandem, but that this correlation could not be explained by parallel changes in dividend payments. A few years later Barry Eichengreen and Andrew Rose of the University of California, Berkeley, and Charles Wyplosz of the Geneva Graduate Institute looked at 20 currency crises in industrial economies between 1959 and 1993. They found that a crisis in one country increased the probability of crises in others.


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