Correlates of Crisis Induced Credit Market Discipline: The Roles of Democracy, Veto Players, and Government Turnover

Abstract

Do countries learn from their mistakes? Here we consider one example of this question with respect to banking crises using the concept of effective learning, that is learning plus the ability to implement such learning. Excessive credit growth is widely considered to be the most important contributor to banking crises. Thus, it is interesting to see whether banking crises are associated with lower rates of credit growth in the future and if so, what are major factors which influence such changes in behavior. In previous research we have found that on average banking crises are followed by substantially lower rates of credit growth but this varies considerably across countries. Our hypothesis is that lower rates of future credit growth reflect a process of learning from one's mistakes and taking corrective actions. This paper offers an investigation of some of the political economy factors that may influence whether crises result in greater discipline over future credit growth. Overall, we found very little average effective learning in stable autocracies and on the contrary, found considerable discipline in stable democracies; nevertheless, we found even larger discipline effects in countries that transitioned to democracy during and in the wake of a banking crisis. Our results regarding the role of veto players and government turnovers are inconclusive. 1 All of the authors are also associated with the Claremont Institute for Economic Policy Studies. We thank Mark Copelovitch, Andreas Kern, David Steinberg and Meredith Wilf for valuable comments and suggestions.