Contagion: Understanding How It Spreads

Much of the current debate on reforming the international financial architecture is aimed at reducing the risks of contagion—best defined as a significant increase in cross-market linkages after a shock to an individual country (or group of countries). This definition highlights the importance of other links through which shocks are normally transmitted, including trade and finance. During times of crisis, the ways in which shocks are transmitted do seem to differ, and these differences appear to be important. Empirical work has helped to identify the types of links and other macroeconomic conditions that can make a country vulnerable to contagion during crisis periods, although less is known about the importance of microeconomic considerations and institutional factors in propagating shocks. Empirical research has helped to identify those countries that are at risk of contagion as well as some, albeit quite general, policy interventions that can reduce risks.