What If Ireland Defaults? Read Online Free PDF

have noted, the aggregative effect may still be negative (see also Paasche, 2001.)
    In this section we have discussed several alternative theories of financial contagion. Of the various theories, the pure contagion models are the least plausible. As Stiglitz (1999b) notes, while Brazil and Russia had few risk factors in common with Southeast Asian economies, both countries saw significant capital flight in the immediate aftermath of the Asian crisis. Similarly, Brazil suffered in the aftermath of the Russian crisis. In those cases, the effects arose from financial institutions and hedge funds with portfolio exposures to multiple emerging markets both within and outside of Asia, and especially from the financial constraints faced by those firms. More recently, disproportionate contractions in lending by banks in the crisis-affected countries helped spread crises to Eastern Europe and emerging markets.
    Our discussion of the circumstances that precipitate contagion and spread of shocks to multiple economies has important policy implications for countries with significant international capital market linkages, including Ireland, which we discuss in the next section.
    Contagion and Financial and Capital Market Liberalisation
    Short-Run Exchange Rate Interventions
    A standard response to the threat of contagion includes an international bailout package, the essential ingredient of which is a commitment of large amounts of financial support, some of which is used immediately for intervention to support the currency, and the rest is left to convince the market that more support will be provided, should the need occur. As Stiglitz (1999a) has commented, there are two things that are odd about these interventions, which often are ineffective (for example, in Russia in 1998, in East Asia in 1997 and in Argentina in 2001). First, why should a temporary intervention in the market have persistent effects? Moreover, if the crisis conveyed information about Mexico’s fundamentals that are relevant to Argentina’s situation, then even if the IMF intervention stabilised Mexico’s exchange rate, it would not change market perceptions of the underlying weaknesses in Argentina’s economy. Only if market participants were naïve enough just to look at the exchange rate (the outcome of market processes and intervention) would the intervention work. 20 And secondly, why should an intervention in Mexico have any effect on Argentina? On the contrary, if the market thought that intervention was necessary but that intervention on behalf of Argentina was less likely than in the case of Mexico, an intervention in Mexico, even if successful in supporting the Mexican exchange rate, could have an adverse effect on Argentina.
    There are two sets of models in which such temporary interventions might make sense. The first is in the presence of deep market irrationalities – where market participants are truly naïve and only look at exchange rates, not what brings them about; where they have simple beliefs about contagion – that a crisis in one country is like a communicable disease, and if we cure the symptoms in one country, it can affect its spread to others. The other is that there are multiple equilibria, and interventions help to move the economy from the ‘bad’ equilibrium to the ‘good’ one. A third explanation, which is a variant of the second explanation, is that markets are often prone to overshooting and interventions are an attempt to prevent that. Given the real consequences of overshooting discussed earlier, such interventions may make sense. Note that in each of these explanations market processes on their own are assumed to lead to sub-optimal outcomes. But the advocates of these interventions at the international financial institutions, which typically have placed strong confidence in the efficiency and stability of market processes, need to provide a clear delineation of the circumstances in