Luiss Open: How to avoid financial contagion
A key question in predicting the economic impact of the coronavirus is whether the shock will be temporary—meaning if the economy will return to its pre-lockdown level—or if the drop in income will not be quickly absorbed. This depends on how many Italian companies go bankrupt due to a liquidity crisis caused by declining sales. It takes a long time for bankruptcies to be absorbed, which prolongs the effects of the shock. Defaults could amplify financial contagion to other businesses, creating a ripple effect across the entire economy and even impacting the few sectors not affected by this crisis. In a short time, NPLs would start growing again, and the contagion would spread to the financial sector as well.
At this stage, the primary goal of economic policy is therefore to prevent bankruptcies. It's a shared goal, and the institutions have responded correctly: whatever it takes. But for it to work, it needs to be credible, so it would be helpful to have an idea of how much it takes. Given Italy's public debt, a promise to guarantee anything could lack credibility and thus be ineffective.