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5 - Cabinet Dissolutions and Interest Rate Behavior

Published online by Cambridge University Press:  02 December 2009

William Bernhard
Affiliation:
University of Illinois, Urbana-Champaign
David Leblang
Affiliation:
University of Colorado, Boulder
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Summary

In this chapter, we investigate the political impact of financial market behavior by focusing on the costs of borrowing. We show that expectations of political outcomes can affect interest rates in both the public and private sectors. As market actors are less confident of the government's economic policy commitments, interest rates increase – with potentially harmful consequences for public finances and economic outcomes.

Higher interest rates complicate the task of balancing the state's finances. Citizen demands for expansive social programs and the increasing pool of citizens eligible for state-sponsored retirement plans have dramatically ratcheted up the debit side of the state's ledger. This would not be problematic if the revenue side were expanding as well. Open financial markets, however, have exacerbated the global competition for tax revenues, leading some political economists to suggest that advanced democracies can no longer sustain generous governmental programs and, instead, must engage in a “race to the bottom.” Given these constraints, governments must issue public debt. High interest rates on government debt can add millions of dollars to government balance sheets in terms of debt servicing, limiting their ability to use fiscal policy to satisfy constituents. The cost of borrowing, therefore, significantly constrains the ability of politicians to expand programs or pursue new initiatives – policies that might help them retain office.

Private economic activity is also affected by interest rate behavior.

Type
Chapter
Information
Democratic Processes and Financial Markets
Pricing Politics
, pp. 103 - 137
Publisher: Cambridge University Press
Print publication year: 2006

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