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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
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Torsten Persson & Guido Tabellini, . "Political Economics and Public Finance," Working Papers 149, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  2. Roberto Chang & Andrés Velasco, 2000. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 11-78 National Bureau of Economic Research, Inc.
  3. Persson, Torsten & Tabellini , Guido, 1997. "Political Economics and Macroeconomic Policy," Seminar Papers 630, Stockholm University, Institute for International Economic Studies.
  4. Cukierman, A. & Tommasi, M., 1997. "When Does It Take a Nixon to Go to China," Papers 30-97, Tel Aviv.
  5. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," Boston University - Institute for Economic Development 59, Boston University, Institute for Economic Development.
  6. Peter M. Garber & Lars E.O. Svensson, 1994. "The Operation and Collapse of Fixed Exchange Rate Regimes," NBER Working Papers 4971, National Bureau of Economic Research, Inc.
  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 A & Thaicharoen, Yunyong, 2002. "Institutional Causes, Macroeconomic Symptoms: Volatility, Crises and Growth," CEPR Discussion Papers 3575, C.E.P.R. Discussion Papers.
  9. John Ferejohn, 1986. "Incumbent performance and electoral control," Public Choice, Springer, vol. 50(1), pages 5-25, January.
  10. Frankel, Jeffrey, 2005. "Contractionary Currency Crashes In Developing Countries," Working Paper Series rwp05-017, Harvard University, John F. Kennedy School of Government.
  11. 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.
  12. Stephan Haggard, 2000. "Political Economy of the Asian Financial Crisis, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 107.
  13. Chang, Roberto & Majnoni, Giovanni, 2002. "Fundamentals, beliefs, and financial contagion," European Economic Review, Elsevier, vol. 46(4-5), pages 801-808, May.
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