Bagehot or Bailout? An Analysis of Government Responses to Banking Crises

Political intervention into markets can take a nearly endless number of forms. During the latter part of the twentieth century, there was a widely shared sense that governments should decrease their role in the economy. Still, there were important variations in this trend. In response to onerous banking crises, countries chose policies that varied dramatically between rescuing insolvent banks (Bailout) and enforcing bank closures (Bagehot). Bailouts are often portrayed as regressive wealth transfers from taxpayers to bankers as the result of “crony capitalism.” However, government policy choice may be patterned as much by domestic institutions—political regime and central bank autonomy—and international constraints—economic openness and support from international financial institutions—as by political promises to stand by crony allies in hard times. I test these arguments by fitting a Bayesian hierarchical item response model of policy making that takes full advantage of data on government responses to banking crises.