Question

Explain why the Greece credit crisis can cause contagion effects throughout Europe

Answer 1

The entire world is now an interconnected and interdependent economy post globalization and liberalization. Whatever happens in one economy can in general lead to a contagion effect throughout the world.

There are multiple reasons to believe why the Greece credit crisis can cause contagion effects throughout Europe:

1. Greece credit crisis has opened eyes of the world towards the rising level of debt in the advanced economies. The level of discomfort will rise and economic support to other European nations like Spain, Italy etc may get discontinued. This will spread the Greece like situations to countries like Italy and Spain and then to some other countries in Europe as well.
2. This destabilization of Greece will raise a fundamental question about the countries coming under umbrella of one currency Euro. Different zones in Euro have different productivity growth and there is no common mechanism to ensure fiscal discipline. Investors will be worried and have a cautious approach towards bonds issued by different European countries.
3. The Greece destabilisation will hurt the short term growth rates. Euro will also remain relatively weak to the dollar. Developing countries like China will exploit this opportunity to push its exports. This will further strengthen dollar and weaken Euro thus impacting entire Europe.
4. With entire Europe on "Caution" watchlist and interest rates in developed countries being low, capital will have no other option but to flow into developing countries like China, Brazil, India. This will retard the growth and employment prospects of Euro nations further.
5. Greece will drag down Europe. And Europe in turn will drag down the global growth.