Contagion (Economics) - Explained
What is Contagion?
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Table of ContentsWhat is Contagion?Why is Contagion Important to Economists?A Brief History of Financial ContagionAcademic Research on Contagion
What is Contagion?
Contagion can be referred to as an economic crisis or changes in a regional market which has a total influence on another. In other words, economic breakdown or others in a specific geographic region influences another region. Since the economy of the world has grown over the years with different countries in the common international market, this has given rise to the term. Contagion is described by academics and analysts to have occurred as a result of the global market interdependence. This term has featured independently in varying economies globally or locally.
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Why is Contagion Important to Economists?
Contagions are known as financial crises with the potential to spread quickly and unexpectedly. This is mostly caused as a result of global investment and cross border trade. It can virtually occur in a global or a domestic market. It occurs in a domestic market when a large bank decides to sell her assets off, this, in turn, affects the confidence investors have in other banks. While in the global market as evident in the 1997 crisis, as a result of the devaluation of Thailand's baht, a large portion of East Asian currencies fell by as much as 38 percent, this spreads across East Asia and Southeast Asia. This also affected markets in Latin America and Eastern Europe. Contagions are mostly aggravated byasymmetric information, this results in both unsustainable investments and reactionary market downturns in response to the weakening of these markets. Also to make mention, most larger markets or economies are able to withstand contagious influence, unlike other growing economies. For example, China's economy did not experience contagion whatsoever despite the Asian countries financial crisis.
A Brief History of Financial Contagion
Contagion was first coined in 1997 as a result of the Asian financial market crisis. Though the term has long existed before them but widely named in that year. As a result of this crisis in 1997, there were several pieces of research aimed at determining how an economic crisis in a country affects another. This research discovered that contagion has been active during the nineteenth century since 1825. In that year, a banking crisis that originated in London spread to the rest of Europe and eventually Latin America. This has a global influence on countries' financial systems. As a result of the liberation of the Latin Americans from Spain, Europeans invested in the continent. This made an investment in the continent a rewarding one. As a result of this, in 1825, the bank of England raised its discount rate which led to the stock market crash which spread across Europe and beyond. Another striking example is the global Great Depression in 1929 which was caused as a result of the U.S. stock market crash.