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Strong contagion with weak spillovers

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  • Martin Ellison
  • Liam Graham
  • Jouko Vilmunen

Abstract

In this paper, we develop a model which explains why events in one market may trigger similar events in other markets, even though at first sight the markets appear to be only weakly related. We allow for multiple equilibria and learning dynamics in each market, and show that a jump between equilibria in one market is contagious because it more than doubles the probability of a similar jump in another market. We claim that contagion is strong since equilibrium jumps become highly synchronised across markets. Spillovers are weak because the instantaneous spillover of events from one market to another is small. To illustrate our result, we demonstrate how a currency crisis may be contagious with only weak links between countries. Other examples where weak spillovers would create strong contagion are various models of monetary policy, imperfect competition and endogenous growth

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 30.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:30

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Keywords: contagion; escape dynamics; learning; spillovers;

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  1. Noah Williams, 2003. "Small Noise Asymptotics for a Stochastic Growth Model," NBER Working Papers 10194, National Bureau of Economic Research, Inc.
  2. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 587-602, August.
  3. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  4. In-Koo Cho & Noah Williams & Thomas J. Sargent, 2002. "Escaping Nash Inflation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 1-40.
  5. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 1999. "A Simple Model of Monetary Pollicy and Currency Crises," Working Papers 99.05, Swiss National Bank, Study Center Gerzensee.
  6. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003 132, Society for Computational Economics.
  7. Giorgio Primiceri, 2005. "Why Inflation Rose and Fell: Policymakers' Beliefs and US Postwar Stabilization Policy," NBER Working Papers 11147, National Bureau of Economic Research, Inc.
  8. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series 2003/38, Center for Financial Studies (CFS).
  9. Bruce McGough, 2003. "Shocking Escapes," Computing in Economics and Finance 2003 294, Society for Computational Economics.
  10. Gerali, Andrea & Lippi, Francesco, 2001. "On the 'Conquest' of Inflation," CEPR Discussion Papers 3101, C.E.P.R. Discussion Papers.
  11. Robert Tetlow & Peter von zur Muehlen, 2004. "Avoiding Nash Inflation: Bayesian and Robus Responses to Model Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 869-899, October.
  12. Kenneth Kasa, 2004. "Learning, Large Deviations, And Recurrent Currency Crises," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(1), pages 141-173, 02.
  13. William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The conquest of South American inflation," Working Paper 2006-20, Federal Reserve Bank of Atlanta.

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