International Financial Contagion: The Theory, Evidence and Policy Implications

This paper reviews the analytical and empirical literature on contagion. It begins by discussing how to define contagion, the theoretical evidence on how it might occur, and the empirical literature evaluating its causes during the financial crises of the 1990s. There has been less contagion during recent crises, however, as countries, investors, and the international financial institutions have learned from past experiences and undertaken a number of reforms. Nonetheless, the risk of international financial contagion during future crises still exists. The paper concludes with a discussion of several policy measures for countries, investors, and the international community. Although there is no way to fully insulate countries from crises that occur elsewhere, these steps would reduce the likelihood and intensity of any contagion in the future. For the Conference ‘The IMF ́s Role in Emerging Market Economies: Reassessing the Adequacy of its Resources’ organized by RBWC, DNB and WEF in Amsterdam on November 18-19. The opinions expressed do not represent those of the World Bank or the U.S. Council of Economic Advisors.