Contagion and the European debt crisis

Abstract

The financial and economic crisis that started in August 2007 is a clear case of the materialisation and propagation of systemic risk. The banking crisis reached a climax in September 2008 with the demise of Lehman Brothers and the subsequent support to the financial system. In spring 2010, it turned into a sovereign debt crisis. Widespread instabilities repeatedly reached new heights since the summer of 2011. This article addresses a phenomenon which is at the very centre of what we are experiencing in the euro area, the phenomenon of contagion. Contagion is one of the mechanisms by which financial instability becomes so widespread that a crisis reaches systemic dimensions. The article argues that contagion phenomena play a crucial role in exacerbating the sovereign debt problems in the euro area. As a consequence, crisis management by all competent authorities should focus on the policy measures that are able to contain and mitigate contagion. Several of the European Central Bank’s (ECB) interventions have been motivated by the need to address contagion.

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