The impact of political institutions on U.S. state bond yields during crises: evidence from the 2008 credit market seizure

This study examines how political institutions mediate bond market reactions to severe economic crisis, based on U.S. states’ experience of the 2008 credit market seizure. Following severe fiscal shocks, political institutions assume greater importance in assessing risk characteristics of state bonds. The bond market reacts most strongly to two factors: public sector union strength in a state and the proportion of Democrats in the state legislature. We suggest that the identity of political institutions becomes increasingly important, during periods of economic crises, when credit markets might expect that political systems can no longer delay stabilisations and must deliver policy.