What began as a singular sovereign debt problem in Greece in 2009 quickly spread to the rest of Europe. First Ireland; then Portugal and Spain and Italy. Today—only three years after the first signs of trouble—virtually all Europeans have felt the destructive effects of the euro zone turmoil, and its impact is being felt around the world.
Contagion, a phenomenon where financial tumult in one country or region spreads to another country, is now a fact of life. The globalization of finance has, in many ways, made contagion inevitable. The world has become much more integrated through trade, investors, and banks, and these ties have caused countries’ financial markets to move together more closely during good times and bad. Read More »
In 2009 when my colleagues at the National Bureau of Economic Research and I began planning a conference for a project we’re running on the global financial crisis, we were concerned that the material would no longer be timely when the symposium actually occurred. We needn’t have worried.
I’ve just returned from Washington, DC, where our symposium was held, and again financial crises were the topic of the day. Three years after cracks in the subprime mortgage market erupted into the most severe and synchronized global financial crisis and recession since the Great Depression, the world economy is once more in dangerous territory. What began as a singular sovereign debt problem in Greece has spread to the rest of Europe, and now threatens to become a second act to the first financial crisis. How did we get here? And how can we keep it from happening again?
It started with Greece and its $100-plus billion bailout package last May. Next came Ireland: in November, it accepted a similarly hefty financial rescue. And now the European debt crisis is at risk of spreading like a virus to countries perceived by the markets to have similar vulnerabilities. Other countries that appear at risk for financial problems include Portugal, Spain and Italy.
As I watch these events unfolding across the Atlantic, the economist in me is fascinated to see that financial crises continue to be part of our landscape. I’ve spent a large part of my professional life studying how financial crises spread from country to country and Europe’s sovereign debt predicament is a living and breathing example of my academic research. Theoretical and empirical models help us understand pieces of otherwise complex dynamics that have been, and continue to be, the fundamental drivers of financial crises.
My biggest worry is that contagion often creates a self-fulfilling destabilizing effect that can spread otherwise ‘isolated’ episodes of stress to other markets and countries. It has a momentum of its own. And as the world’s economies are trying hard to pull through from the credit crisis and the global downturn that started in mid-2007, I worry about the immediate and longer-term challenges facing Europe. It’s clear that Europe is struggling mightily to prevent the debt crisis from overwhelming more countries and support a fragile recovery, but containing contagion is not easy. Read More »