The Political Economy of Federal Systems in Times of Economic Crisis

Abstract

This dissertation examines how political institutions, as dynamically affected by voters and legislatures, mediate financial market reactions to severe fiscal shocks. This work uses as its case studies the experience of the U.S. states following the 2008 credit market seizure, and that of the German states following the financial crisis. It is found that following credit market seizures and severe fiscal shocks, political institutions become more important to market participants in assessing the risk characteristics of state bonds. Specifically, while unexpected deficits are correlated with higher state bond yields across all states, this effect is larger for states with left-leaning political systems than for states with right-leaning political systems. These results suggest that during economic crises – when credit markets might expect that political systems can no longer delay stabilizations – the identity of the political institutions and actors “behind the markets” become increasingly important.