Moral Hazard and Financial Crises: Evidence from US Troop Deployments

Abstract

International lenders of last resorts are often accused to create financial instability because they generate moral hazard. The evidence for this is thin and plagued with measurement error. Examining the case of the US, we use the number of American troops hosted by third countries to measure how strongly the US is committed to them. We find that increasing the number of US troops by one standard deviation above the mean raises the probability of a financial crisis in the host country by about 12 to 14 percentage points. We also investigate the channels through which moral hazard materializes. Countries with more US troops conduct more expansionary fiscal and monetary policies, implement riskier financial regulations, and receive more capital, especially from US banks. These findings are inconsistent with reverse causality.

Keywords: financial crisis, moral hazard, US troops