Financial instability, political crises and contagion

Victor Vaugirard
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Victor Vaugirard: Faculty of Social Sciences, University of West Indies, Trinidad and Tobago

No 2007041, Discussion Papers (REL - Recherches Economiques de Louvain) from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: This paper studies banking liquidity crises under the assumption that the government may have private benefits in bailing-out a collapsing banking sector for reputation concerns. This political distortion feeds political uncertainty, as citizens may not agree with a bailout decision and overthrow the government. This paper shows that higher political uncertainty increases both fînancial and political instabilities as it enlarges the set of parameters for which bank runs and the dismissal of the government are optimal. Higher political uncertainty may stern from the occurrence of a politico-financial crisis in another similar country. Contagion takes place if citizens update their beliefs on the type of their government. Doing so, they may reinforce their beliers that the government is self-interested and bank bailouts are not socially optimal.

Keywords: Banking liquidity crisis; bailout; political crisis; contagion (search for similar items in EconPapers)
JEL-codes: D8 F3 G2 (search for similar items in EconPapers)
Pages: 22
Date: 2007-12-01
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:ctl:louvre:2007041

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