Are Crises Like Colds?

Crises often occur in clusters, affecting multiple countries in the same region. So says Professor Andrew K. Rose, the Central Bank of Barbados’ 5th Distinguished Visiting Fellow. Given this, is it fair to say that crises are contagious?

Speaking during a webinar for regional central banks on the topic “Contagion in Banking and Currency Crises”, which included participants from the Bank of Guyana, Central Bank of Belize, Central Bank of Trinidad and Tobago, Centrale Bank von Suriname, and the Eastern Caribbean Central Bank, Rose, a Professor of Economic Analysis and Policy at the University of California, Berkeley whose research includes international trade, exchange rates regimes, and crises, gave an answer: yes and no.

Currency crises, Rose said, are often contagious, with one country being hit by a crisis and then “infecting” the others. He explained that because countries that are geographically close tend to engage in a significant amount of trade with each other, when one country is struck by a crisis that results in the value of its currency falling, that country gains a competitive advantage over its trading partners. That in turn puts pressure on the other countries’ economies, which can lead to them having exchange rate crises of their own.

Financial crises, however, are not contagious but rather are caused by what he terms a “common shock” that impacts different countries at different rates depending on their resilience. Using the analogy of a medical illness, Rose likened currency crises to someone catching a cold and then spreading it to other people he came into contact with, while he described banking crises as more akin to a virus circulating in the atmosphere that sickens the person with the weakest immune system first before gradually felling those who are healthier.

Drawing on the Caribbean as an example, Rose said events in North American markets, such as an increase in interest rates or a slowdown in economic growth, could lead to a financial crisis that would affect the entire region. Territories with less resilient financial systems would feel the impact first, but eventually almost all countries would experience the crisis.

Although it is possible to understand how crises occur, predicting them is a more challenging proposition. Asked about this, Rose dismissed the idea that an automated Early Warning System (EWS) was the solution. Rose, who has done extensive research trying to develop such a model, said EWS’s do not work and instead advocated that economists devote their time and resources to monitoring their countries’ economies, to keeping an eye on international events and trends, and to building resilience to buffer the impact of a crisis when it occurs.