ECON 319 Lecture 5: Contagion-by-Dornbusch-notes
9 Feb 2017
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Document Summary
Fischer (1998), for example, notes two important reasons for revamping the international financial architecture and smoothing the global economy. First, the high degree of volatility of international capital flows to emerging markets and these markets" limited ability to deal with this volatility make the recipient country vulnerable to shocks and crises that are excessively large, frequent, and disruptive. Second, international capital markets appear to be highly susceptible to contagion. Thus proposals to reform the international financial architecture must be based on a thorough understanding of the causes and consequences of contagion. Takeaway from the reading in terms of the meaning and causes of contagion: An increase in comovement need not reflect irrational behavior on the part of investors. When one country is hit by a shock, liquidity constraints can force investors to withdraw funds from other countries. Because many financial transactions are conducted by agents rather than by principals, incentive issues also play a role in triggering volatility.
