International Economics Update December 2001 Copyright (C) 2001 The International Economics Network http://www.internationaleconomics.net Marginal Notes. Defining Contagion There is no singular definition of contagion. The World Bank has represented contagion according to three definitions: one broad, another more restrictive, and the last very restrictive. The broad definition of contagion defines it as the cross-country transmission of shocks or any general cross-country spillover effect - whether real, financial, or from exogenous sunspots. Contagion can then take place both during the tranquil and crisis periods; here, contagion does not need to be related to crises. However, studies on contagion have tended to emphasize crisis periods, such as the EMS crisis of 1992-93, or, more relevant to this study, the Asian financial crisis. A slightly more restrictive definition of contagion is that it is the transmission of shocks to other countries or, more generally, significant cross-country correlations that exist beyond any fundamental links between countries and beyond common shocks. This definition is usually referred as excess co-movement, and is commonly explained by herding behavior leading to sunspots. The most restrictive definition of contagion is that the phenomenon occurs when cross-country correlations increase during the crisis period relative to correlations during the tranquil period. However, this final definition tends to be too exclusive, as it lends itself to the possibility of strong statistical relationships that might not be related to any underlying economic theory. The literature has generally been divided as to whether transmission through real or financial channels constitutes contagion [1]. Later researchers have therefore tended to adopt the semantic that "pure" contagion is unrelated to these two transmission channels, and is hence entirely captured by shifts in market actors' perceptions and attitudes towards risk. The first two forms are referred to merely as interdependence or spillovers. However, it has been argued that contagion is best defined as a significant increase in cross-market linkages after a shock to an individual country or group of countries (Dornbush, Park & Claessens 2000). This definition is attractive as it asserts that contagion arises due to a shift in cross-market linkages; a tendency that is often phrased as "shift-contagion" (Forbes & Rigobon 1999a, b). For this reason, this definition will form the basis of this current study, and the problems that arise from the somewhat contrived notions of interdependence versus pure contagion can be safely omitted. Endnotes 1. Real linkages have been identified by the theoretical literature to be shocks propagated via trade, policy coordination, country reevaluation, and random real global shocks (the so-called non crisis-contingent theories), whilst monetary linkages include multiple equilibria due to shifts in investor expectations, endogenous liquidity shocks, political contagion, and random global monetary shocks (the crisis-contingent theories). For an overview of this literature, see Forbes & Rigobon (1999b). References Dornbusch, R., Y.C. Park & S. Claessens (2000), 'Contagion: How It Spreads and How It Can Be Stopped', Proceedings of the World Bank Conference on International Financial Contagion, Washington D.C., Feb 3-4, 2001. Forbes, K. & R. Rigobon (1999a), 'No Contagion, Only Interdependence: Measuring Stock Market Co-movements', NBER Working Paper no. 7267. Forbes, K. & R. Rigobon (1999b), 'Measuring Contagion: Conceptual and Empirical Issues', Proceedings of the World Bank Conference on International Financial Contagion, Washington D.C., Feb 3-4, 2001. Website Additions. No major new additions this month, unfortunately, although updates continue to be made on the news and research papers section. Interesting Readings. 1. On the Failure of Markets: Joseph Stiglitz, the recent 2001 receipient of the Nobel Prize, argues that there are good reasons why markets don't work, and believes that the so-called 'free-market fundamentalism' favoured by the developed nations may well be asymmetric in nature (Nobel laureate squarely in anti-globalization camp', http://www.atimes.com/global-econ/CJ16Dj01.html). 2. Finally, Though It Took Awhile: Argentina has effectively decided to restructure its debt plan. The two choices: between a modest write-down and a float of the peso (as proposed by Ricardo Hausmann in 'Editorial comment: Argentina's hope', http://tm0.com/sbct.cgi?s=185070289&i=412319&d=1952394), and the continued maintenance of the currency board with a larger write-down (favoured by the Argentine government), both appear to be difficult to stomach. However, there are lessons to be learnt from all this, as Martin Wolf surmises ('Time for Plan B in Argentina', http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT37JOK3GTC&live=true&tagid=ZZZU2IUKJ0C). Was it a disaster waiting to happen? Yes, so say Manuel Pastor and Carol Wise, writing in the Nov/Dec issue of Foreign Affairs ('From Poster Child to Basket Case', http://www.foreignaffairs.org/articles/Pastor1101.html). Endnotes. This update is sent by request to subscribers. If you wish to join the mailing list, please click on: http://www.internationaleconomics.net/contact.html And enter your email address on the form there. You will receive a verification message confirming your subscription to the International Economics Update mailing list. Please feel free to forward this mailing on to colleagues and friends who might be interested in the subject matter. The usual disclaimers apply. This mail is not spam. You have received this mailing only because you are on the International Economics Update mailing list, for which it is believed that you have voluntarily subscribed to. If you believe that this message was sent in error, or if you wish to remove yourself from the mailing list, please send an e-mail to: webmaster@internationaleconomics.net and you will be removed promptly. Alternatively, you may click on the link below.