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Crises and Contagion: A Survey

Knyazeva, Anzhela; Knyazeva, Diana; Stiglitz, Joseph E.

There is a large literature on crises and contagion. This survey focuses on the theory, and in particular on how to reconcile crises with standard neoclassical theory and macroeconomics. A central thesis of this survey is that understanding crises requires an understanding of market imperfections – and especially of the constraints, for instance, on borrowing, imposed by imperfect information – and how those market imperfections interact with irrationalities on the part of market participants and imperfections in the regulatory environment. This paper is divided into three sections. The first surveys the literature on what causes crises; the second on contagion and the effect of interdependence in amplifying crises; the third on the role of government. Not surprisingly, theories which stress the efficiency and stability of markets look to government as the source of the problem; stability is attained by government not interfering in the natural workings of the market. Theories which see the economy as inherently inefficient and unstable look to government to help correct market failures. Ascertaining which of these theories is correct is not easy, and beyond the task of this short survey. One of the reasons for the difficulties is that there are elements of many of the alternative approaches present in every crisis. No one could look at the recession of 2008 or the Irish banking crisis without noting market irrationalities. But does that mean we could not have had a crisis in the absence of such irrationalities? The major shock was an endogenous one – a housing bubble; the shock was not an exogenous event (‘a once in a hundred year flood’) but there were exogenous (at least to the economic system) events that perhaps could have triggered a major downturn, reflected in the spike in oil and food prices.

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Title
What if Ireland Defaults?
Publisher
Orpen Press

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Economics
Published Here
April 15, 2019
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