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Electoral Uncertainty and the Volatility of International Capital Flows

  • Roberto Chang

I study a small open economy in which elections affect and are affected by capital inflows. Two candidates, one favoring workers and another favoring entrepreneurs, run for office; the winner chooses taxes, which affect investment returns. A pro labor victory results in a "sudden stop" in investment and capital flows, reflecting a time inconsistency problem. The pro business candidate is free from time inconsistency but becomes less attractive to voters if the foreign debt is larger. Hence electoral outcomes depends on the size of the debt, which itself depends on expectations about the election. The model's politico economic equilibria has several implications. Politico economic links exacerbate the responses of financial variables to exogenous shocks. Self fulfilling equilibria may exist. Policies that alleviate the pro labor candidate's commitment problem contribute to financial stability but also, and perhaps more surprisingly, to the chances of a pro labor victory in the elections. A redistribution of wealth has ambiguous although predictable effects on politico economic outcomes.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12448.

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Date of creation: Aug 2006
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Handle: RePEc:nbr:nberwo:12448
Note: IFM POL
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  1. Roberto Chang, 2002. "Financial Crises and Political Crises," Departmental Working Papers 200229, Rutgers University, Department of Economics.
  2. 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.
  3. Christian B. Mulder & Matthieu Bussière, 1999. "Political Instability and Economic Vulnerability," IMF Working Papers 99/46, International Monetary Fund.
  4. Paul R. Masson, 1999. "Multiple Equilibria, Contagion, and the Emerging Market Crises," IMF Working Papers 99/164, International Monetary Fund.
  5. Stephan Haggard, 2000. "Political Economy of the Asian Financial Crisis, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 107, December.
  6. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  7. repec:rus:hseeco:72137 is not listed on IDEAS
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