Political risk, populism, and the economy

We study the financial and real effects of political risk shocks for Italy, Spain, Ireland, Portugal, and Greece between 2008 and 2019. We build an instrument for these shocks using the changes of the sovereign yield spread around political and policy dates and estimate their effects in the context of Local Projection. We show that adverse political risk shocks have negative effects on domestic financial markets and in some countries generate spillovers on the spreads of other euro-zone economies. Moreover, in Italy populism-related political risk shocks have a larger effect on financial markets and they harm the real economy.