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Financial crises and political crises

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  • Chang, Roberto

Abstract

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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Suggested Citation

  • Chang, Roberto, 2007. "Financial crises and political crises," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2409-2420, November.
  • Handle: RePEc:eee:moneco:v:54:y:2007:i:8:p:2409-2420
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    Cited by:

    1. Emanuel Kohlscheen, 2010. "Sovereign risk: constitutions rule," Oxford Economic Papers, Oxford University Press, vol. 62(1), pages 62-85, January.
    2. Dejan Eric & Ivan Stosic, 2012. "Development of European Financial System: Challenges for the Balkan Countries Integration Process," Book Chapters, Institute of Economic Sciences.
    3. Martínez, Juan & Santiso, Javier, 2003. "Financial Markets and Politics: The Confidence Game in Latin American Emerging Economies," MPRA Paper 12909, University Library of Munich, Germany.
    4. Dejan Eric & Aleksandar Zdravkovic & Drasko Nikolic, 2009. "Influence of World Crisis on Western Balkans Countries – Undertaken Measures and Expected Effects," Book Chapters, Institute of Economic Sciences.
    5. Guillermo Ordonez & Christoph Trebesch & Helios Herrera, 2013. "Political Booms, Financial Crises," 2013 Meeting Papers 224, Society for Economic Dynamics.
    6. Sandro C. Andrade & Emanuel Kohlscheen, 2010. "Pessimistic Foreign Investors and Turmoil in Emerging Markets: the case of Brazil in 2002," Working Papers Series 211, Central Bank of Brazil, Research Department.
    7. Galina Hale, 2005. "Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over," The Institute for International Integration Studies Discussion Paper Series iiisdp062, IIIS.
    8. Carvalho, João Vinícius de França & Chiann, Chang, 2013. "Redes Bayesianas: Um método para avaliação de interdependência e contágio em séries temporais multivariadas," Revista Brasileira de Economia - RBE, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil), vol. 67(2), June.
    9. Betty C. Daniel, 2012. "Private Sector Risk and Financial Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 122(561), pages 825-847, June.
    10. Mahmoud Haddad & Sam Hakim, 2008. "The Impact of War and Terrorism on Sovereign Risk in MENA Countries," Working Papers 394, Economic Research Forum, revised 03 Jan 2008.
    11. repec:eee:inecon:v:108:y:2017:i:c:p:37-53 is not listed on IDEAS
    12. Hasman, Augusto & López, Ángel L. & SamartIín, Margarita, 2011. "Government, taxes and banking crises," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2761-2770, October.
    13. Pastén, Roberto & Cover, James P., 2015. "Tax tilting and politics: Some theory and evidence for Latin America," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 208-218.
    14. Scholl, Almuth, 2017. "The dynamics of sovereign default risk and political turnover," Journal of International Economics, Elsevier, vol. 108(C), pages 37-53.
    15. Timm M. Prein & Almuth Scholl, 2018. "The Impact of Bailouts on Political Turnover and Sovereign Default Risk," Working Paper Series of the Department of Economics, University of Konstanz 2018-04, Department of Economics, University of Konstanz.
    16. Moser, Christoph, 2007. "The Impact of Political Risk on Sovereign Bond Spreads - Evidence from Latin America," Proceedings of the German Development Economics Conference, Göttingen 2007 24, Verein für Socialpolitik, Research Committee Development Economics.
    17. Roberto Chang, 2006. "Electoral Uncertainty and the Volatility of International Capital Flows," NBER Working Papers 12448, National Bureau of Economic Research, Inc.
    18. Ionescu Cristian, 2012. "Financial Instability And Political Instability," Annals - Economy Series, Constantin Brancusi University, Faculty of Economics, vol. 4, pages 154-158, December.
    19. Van Rijckeghem, Caroline & Weder di Mauro, Beatrice, 2004. "The Politics Of Debt Crises," CEPR Discussion Papers 4683, C.E.P.R. Discussion Papers.
    20. Carlo de Bassa Scheresberg, Francesco Passarelli, 2011. "Strategic Sovereign Defaults under International Sanctions," ISLA Working Papers 42, ISLA, Centre for research on Latin American Studies and Transition Economies, Universita' Bocconi, Milano, Italy.
    21. Roberto Pasten & James P. Cover, 2010. "The Political Economy of Unsustainable Fiscal Deficits," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 47(136), pages 169-189.
    22. Victor Vaugirard, 2005. "Crony Capitalism and Sovereign Default," Open Economies Review, Springer, vol. 16(1), pages 77-99, January.
    23. repec:fgv:epgrbe:v:67:n:2:a:3 is not listed on IDEAS

    More about this item

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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