There Was No Contagion
If you use the word contagion these days, people are likely to think you’re talking about ebola. Back up five years ago, however, and contagion was the buzzword to describe the financial crisis.
The European government bond market was falling apart, and allegedly it had nothing to do with the precarious public finances they were built on. Instead, the excuse was that there were a couple bad apples (Greece, Ireland, and then Portugal), and these isolated cases were shaking investors’ nerves and causing them to be irrationally weary about supposedly “safe” countries, like France or Germany.
At the time, I said it was a completely ridiculous use of the word contagion, as normally one would only use that if the person infected was not culpable in transmitting the disease.
The one common theme amongst European public finances was that they had high tax rates and even higher levels of expenditure. Deficits, extremely large in some cases (Ireland), were practically the norm. If countries were having a tough go issuing more debt, it wasn’t because of some vague cause like contagion, but because of years of bad political choices left them in terrible financial shape.
As it turns out, two NBER economists have drawn the same conclusion with a retrospective look at the Eurocrisis. Not only could they find only very small “spillover effects” (contagion) during the crisis, but investors didn’t seem that worried either.
Of course, if there was no contagion, and investors weren’t even erroneously acting like there was one, who was behind all the talk? As always, politicians searching for an excuse for their shoddy finances latched on to a notion and got the world worked up in a frenzy, giving them free reign to pass whatever policies they liked to keep their financial endgame going a little while longer.
(Cross posted at Mises Canada.)