Partisan Financial Cycles

Abstract

Little attention has been given to the partisan character of government as a cause--or a consequence--of financial crises. I argue that policies and regulations vary predictably with the partisan character of the government, creating a partisan-policy financial cycle in which right-wing, pro-market governments preside over financial booms while left-wing governments are elected to office after crashes. My sample consists of all bank-centered financial crises to hit advanced countries since the end of the Bretton Woods system in 1973, including the recent “subprime” crises—a total of 27 cases. I find that governments in power prior to major financial crises are more likely than the OECD average to be right-of-center in political orientation. I also find that these governments are more likely than average to be associated with policies that precipitate crises: large fiscal and current account deficits, heavy borrowing from abroad, and lax bank regulation. However, once a major financial crisis occurs, the causal arrow flips and government partisanship becomes a consequence of crises. I find that the electorate moves to the Left after a major financial crisis, and this leftward shift is associated with changes in government partisanship in that direction.

Keywords: financial crises, political parties, political business cycles

JEL Classification: F30, F32, G01