The Politics of Bilateral Currency Swap Agreements

• In Event: Poster Session: International Political Economy II & Conflict Processes I
  In Poster Session: Poster Session: International Political Economy II

Abstract

Why do central banks provide emergency financing to some foreign recipients but not others? Prevailing research suggests that powerful countries provide emergency financing to their allies on favorable terms, thereby creating a moral-hazard problem in which allies continue to engage in economic misbehavior (Stone 2002; Schneider and Tobin 2017; Lipscy and Lee 2018). I argue that this result stands at odds with general theories of central bank emergency lending that contend a provider’s overriding goals are to minimize the probability of recipient collapse and to reduce the cost of economic contagion (Allen 2013; Aizenmann et al. 2011; Broz 2015; McDowell 2017). Why are central banks more willing to provide direct lines of credit to allies if doing so encourages a cycle of economic mismanagement? I resolve this puzzle using new theory and data on Bilateral Swap Agreements (BSAs). I first present a formal model of the provider-recipient interaction that highlights additional risks that providers face when extending BSAs to recipients who decline economic reforms. In contrast to previous work, I demonstrate that providers can use political ties to manage these risks: international linkages enable providers to credibly threaten punishment and thereby induce better behavior from swap recipients. By leveraging the political ties of their home countries, providers can extend BSAs to recipients whose requests they would otherwise reject and can reduce the long-term risk of economic collapse and spillover. I provide empirical support for the mechanism using a newly-created dataset of all swap agreements offered by the U.S. Federal Reserve, the People’s Bank of China, and the Bank of Japan between 2000 and 2016.

Author

• Abigail Vaughn, Princeton University