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Financial Crises and Political Crises

  • Roberto Chang

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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File URL: http://www.nber.org/papers/w11779.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11779.

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Date of creation: Nov 2005
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Publication status: published as Chang, Roberto. “Financial Crises and Political Crises.” Journal of Monetary Economics 54 (2007): 2409-2420.
Handle: RePEc:nbr:nberwo:11779
Note: IFM POL
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  1. Torsten Persson & Guido Tabellini, 1997. "Political Economics and Macroeconomic Policy," NBER Working Papers 6329, National Bureau of Economic Research, Inc.
  2. 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.
  3. Cukierman, A. & Tommasi, M., 1997. "When Does It Take a Nixon to Go to China," Papers 30-97, Tel Aviv.
  4. Chang, Roberto & Majnoni, Giovanni, 2002. "Fundamentals, beliefs, and financial contagion," European Economic Review, Elsevier, vol. 46(4-5), pages 801-808, May.
  5. Jeffrey A. Frankel, 2005. "Contractionary Currency Crashes in Developing Countries," NBER Working Papers 11508, National Bureau of Economic Research, Inc.
  6. Garber, Peter M. & Svensson, Lars E.O., 1995. "The operation and collapse of fixed exchange rate regimes," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 36, pages 1865-1911 Elsevier.
  7. 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.
  8. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," Boston University - Institute for Economic Development 59, Boston University, Institute for Economic Development.
  9. Stephan Haggard, 2000. "Political Economy of the Asian Financial Crisis, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 107.
  10. 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.
  11. Persson, Torsten & Tabellini, Guido, 1999. "Political Economics and Public Finance," CEPR Discussion Papers 2235, C.E.P.R. Discussion Papers.
  12. John Ferejohn, 1986. "Incumbent performance and electoral control," Public Choice, Springer, vol. 50(1), pages 5-25, January.
  13. Roberto Chang, 1999. "Understanding recent crises in emerging markets," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 6-16.
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