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Financial crises and political crises

  • Chang, Roberto

This paper is an analysis of the simultaneous determination of financial default and political crises and its consequences. It focuses on a small open economy that faces a debt default decision. Crucially, this decision is made by a government that has superior information than the public about the social costs of default. Citizens can dismiss the government, and overrule its default decision, at the cost of a political crisis. If there is a divergence between the objectives of the government and its people, a political crisis may emerge in equilibrium. For this to be the case, the foreign debt must be large enough, and international reserves low. When this political equilibrium is seen as a part of a larger investment problem, there are equilibria in which crises are "only financial," and equilibria in which both default and political crises occur. In some cases, these two kinds of equilibria coexist and, in this sense, a loss of confidence by foreign lenders can exacerbate the likelihood of a political crisis. If so, international intervention in financial markets may ensure financial and political stability at little cost.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 8 (November)
Pages: 2409-2420

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Handle: RePEc:eee:moneco:v:54:y:2007:i:8:p:2409-2420
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  1. Persson, Torsten & Tabellini, Guido, 2002. "Political economics and public finance," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 24, pages 1549-1659 Elsevier.
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  4. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
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  6. Cukierman, Alex & Tommasi, Mariano, 1998. "When Does It Take a Nixon to Go to China?," American Economic Review, American Economic Association, vol. 88(1), pages 180-97, March.
  7. Roberto Chang, 1999. "Understanding recent crises in emerging markets," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 6-16.
  8. Acemoglu, Daron & Johnson, Simon & Robinson, James & Thaicharoen, Yunyong, 2003. "Institutional causes, macroeconomic symptoms: volatility, crises and growth," Journal of Monetary Economics, Elsevier, vol. 50(1), pages 49-123, January.
  9. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
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  13. Stephan Haggard, 2000. "Political Economy of the Asian Financial Crisis, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 107.
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