Business, Legal & Accounting Glossary
Contagion is the cross-border spread of financial shocks. Such international spillover means that economic or financial troubles that originate in one nation can affect others.
Contagion can occur at any time during a business cycle; not just at the trough. Thus, contagion is not necessarily related to a crisis, although this is when contagion is most apparent.
More specifically, contagion is the international spread of shocks in the absence of any shared shocks between the countries.
The links that connect countries are in part responsible for the spread of contagion. There are three main types of links. They are financial links, real links, and political links.
Financial links are present between two nations when two they both use the same international financial system. When leveraged financial institutions face margin calls and the value of their collateral drops, as a result of adverse shocks in one nation, firms that have borrowed must raise their reserves. To do this, they sell off some of their holdings to the countries that have not yet been hit by the shocks. But what this does is it spreads the shocks to other economies.
Real links can be thought of as the economic relationships between countries and economic units, and are typically associated with global trade. When two nations engage in trade between themselves, a discount in one currency erodes the other nation’s competitive advantage. The result is that both countries’ currencies are devalued in order to restore balance in their external sectors.
International FDI is another example of real links.
Political ties between nations can affect shocks between countries. When crises or shocks occur, countries must devalue currencies. If the political ties are strong, the political cost of revaluing the rates is less.
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This glossary post was last updated: 26th March, 2020 | 1 Views.