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Political economy of financial crisis duration

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Abstract

Over the last four decades, banking crises around the globe have become longer. Along with the unprecedented government responses to the Great Recession of 2007–2008, protracted financial crises have led scholars to ask whether political decisions were somehow to blame. Despite growing concerns, little attention has been paid to the political and institutional determinants of financial crisis duration. This paper considers the role of these factors in determining the duration of systemic banking, currency, sovereign debt, and twin or triple coinciding crises. Relying on an extensive database of 125 countries observed over the 1976–2017 period and estimating a discrete-time duration model, we find that the electoral cycle, political ideology, majority governments, institutional quality, and central bank independence matter. This study shows that the duration dynamics of financial crises are idiosyncratic and must be examined individually. Finally, allowing for more flexible duration dependence patterns, we observe that the durations of both banking and twin or triple coinciding crises follow a nonmonotonic cubic model, while the probability of debt crisis ending declines monotonically over time.

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Data availability

The datasets generated during and/or analyzed during the current study are available from the corresponding author on reasonable request.

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Notes

  1. Claessens et al. (2012) examine the duration dependence of economic recessions, which might not necessarily imply financial crises.

  2. The absence of empirical research on the duration of the different types of financial crises might be due to (1) difficulties in identifying different types of financial crises, and (2) the limited number of observations of crisis episodes.

  3. “Twin deficits” refer to the rapid expansion of current account deficits and deterioration of fiscal balances (Broz, 2013).

  4. Voters punish the ruling governments for poor economic conditions and reward those who better control economic issues (Bartels, 2013; Lindvall, 2014).

  5. Right-wing governments’ crisis measures have been proven to be detrimental to the poor in various dimensions such as social protection, health care, pension, and labor market (see, e.g., Shahidi, 2015; Sacchi and Roh, 2016).

  6. BoC-BoE Database of Sovereign Defaults is available at: https://www.bankofcanada.ca/2020/06/staff-analytical-note-2020-13/.

  7. These two groups of countries are identified based on the country classifications of the World Economic Outlook. For details, see https://www.imf.org/external/pubs/ft/weo/2018/02/weodata/groups.htm.

  8. One exception is Mecagni et al. (2007) who examine the determinants of the duration of capital account crisis.

  9. This estimate is obtained from Eq. (4): \(\log \lambda_{t} = \alpha + \left( {p - 1} \right)\log t\). See Allison (2014) for further details.

  10. The duration of all crises “in general” may not accurately capture the states of financial crises because the exit state of a type of financial crisis is overlapped by the duration of another type. In this paper, due to the prolonged duration of sovereign debt crises, the probability of exiting crisis states of all crises is highly influenced by the duration of debt crises.

  11. According to Allison (2014), 100(exp(b)−1) corresponds to the percentage change in the hazard with a one-unit increase in the explanatory variable, ceteris paribus.

  12. Alternatively, this can be computed as 100(exp(b)−1), which means that the probability of a currency crisis ending is 40% higher when left-wing governments are in office.

  13. As shown in Table 1, the average duration of banking crises over the period 1970–2017 is 3.74 years in developed countries, while the figure for developing countries is only 2.91 years.

  14. Due to space limitations, the results are not reported here but are available upon request.

  15. The results for all our sensitivity analysis and robustness checks are not reported here but are available upon request.

  16. As CBI data are only available to 2012, regressions are limited to the period 1976–2012.

  17. As the data for INSQL-PCA only cover the period 1985–2017, our models lose several observations.

  18. Due to space limitations, the regression results are not reported here but are available upon request.

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Acknowledgements

The authors thank Ahmad Hassan Ahmad, Sushanta Mallick, Rodrigo Martins, Alistair Milne, Ricardo Sousa, the anonymous referees, and the Editor for their insightful comments and suggestions.

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  1. Faculty of Economics and Business, Phenikaa University, Hanoi, 12116, Vietnam

    Thanh Cong Nguyen

  2. School of Business and Economics, Loughborough University, Epinal Way, Loughborough, LE11 3TU, UK

    Vítor Castro & Justine Wood

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All authors contributed to the study conception and design. Material preparation, data collection, and analysis were performed by TCN. The first draft of the manuscript was written by TCN and all authors commented on previous versions of the manuscript. All authors read and approved the final manuscript.

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Correspondence to Thanh Cong Nguyen.

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Nguyen, T.C., Castro, V. & Wood, J. Political economy of financial crisis duration. Public Choice 192, 309–330 (2022). https://doi.org/10.1007/s11127-022-00986-2

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