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Abstract
This research investigates under what conditions political institutions may induce longer and more expensive financial crisis resolutions by assessing the impact of power distribution on government responses to crisis situations. A new model is elaborated in which power distribution plays a key role in the evolution of financial crises, from their onset to their final resolution. The model allows for the examination of government responses to financial crises along two dimensions: the capacity to resolve the crisis in a timely and decisive fashion, and the extent to which fiscal resources are redistributed to the financial sector.
Two key arguments are developed. First, power concentration in the executive may facilitate responses to financial crises because it minimizes coordination problems and obstructions to the implementation of necessary measures. Second, power concentration implies less competition for public resources and fewer checks on their allocation. As a result, veto holders have more room to follow their own agendas or impose their priorities. During financial crises, this may result in larger fiscal transfers to the financial sector. Support for these arguments comes from two statistical studies on the duration and fiscal cost of 40 crisis episodes across the world, and the analysis of the 1994-95 financial crisis in Mexico.
The statistical studies show that there is a significant relationship between power distribution and the duration and fiscal cost of financial crises. Relevant evidence was also found connecting variations in power distribution to the probability of observing anti-crisis measures – some of which clearly target the financial sector – that significantly increase the price tag of the crises. The Mexican case illustrates how variations in the power of the president shaped the evolution of the 1994-95 financial crisis through their impact on the decision process related to the containment, management and resolution of the crisis.
