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Confidence spillovers, financial contagion, and stagnation

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  • Platonov, Konstantin

Abstract

Financial crises tend to spread across countries, causing equity price crashes that cannot be fully explained by fundamentals. This paper introduces a two-country dynamic general equilibrium model of global financial crises that distinguishes between interdependence and financial contagion. Interdependence arises through trade and capital flows, while contagion occurs through a new channel: confidence spillovers. In the model, contagion is possible due to multiple dynamic and steady-state equilibria, even with fully rational consumers. Self-fulfilling beliefs about equity prices can shift the economy between equilibria, amplifying negative effects and causing contagion. The model has three policy implications. Firstly, monetary policy can offset recessions without causing inflation. Coordinated international policy can potentially improve welfare further. Secondly, capital controls can prevent contagion. Lastly, increased trust in government can mitigate negative confidence shocks. These recommendations emphasize the role of beliefs, where pessimism can spread internationally via the confidence channel, leading to contagion.

Suggested Citation

  • Platonov, Konstantin, 2024. "Confidence spillovers, financial contagion, and stagnation," Journal of International Money and Finance, Elsevier, vol. 148(C).
  • Handle: RePEc:eee:jimfin:v:148:y:2024:i:c:s0261560624001505
    DOI: 10.1016/j.jimonfin.2024.103163
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    Cited by:

    1. Marina Yu. Malkina, 2024. "Financial contagion in the US, European and Chinese stock markets during global shocks," Journal of New Economy, Ural State University of Economics, vol. 25(4), pages 47-67, December.

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    More about this item

    Keywords

    Financial crisis; Contagion; Stagnation; Confidence; Beliefs; Asset prices; Indeterminacy; Multiple equilibria; Endogenous business cycle;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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