The role of expectations in austerity cycles: The political economy of crisis management in Ireland and Greece

The main goal of the paper is to explain the role of expectations in austerity cycles during financial bailouts. The paper presents a political economy model of bailouts, where the conditions, their implementation, and market reception are considered as forms of a social dilemma. In such situations, expectations about the actions of other actors approximated by the concepts of trust or distrust play a critical role. An environment of trust is conducive to mitigating the size and effects of fiscal contraction, while an environment of distrust is likely to magnify both. It is also argued that the credibility of government is the key driving force in these self-reinforcing cycles. The crisis management experiences of Greece and Ireland serve to illustrate the theoretical model.