Political Pressures and Exchange Rate Stability in Emerging Market Economies

Journal of Applied Economics, Vol. 11, No. 1, pp. 1-32, May 2008

Posted: 14 Jul 2008

See all articles by Ester Faia

Ester Faia

Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Massimo Giuliodori

University of Amsterdam - Faculty of Economics & Econometrics (FEE); Tinbergen Institute

Michele Ruta

Economic Research Division, WTO; Columbia Business School - Economics Department; International Monetary Fund (IMF)

Date Written: May 2008

Abstract

This paper presents a political economy model of exchange rate policy. The theory is based on a common agency approach with rational expectations. Financial and exporter lobbies exert political pressures to influence the government's choice of exchange rate policy, before shocks to the economy are realized. The model shows that political pressures affect exchange rate policy and create an over-commitment to exchange rate stability. This helps to rationalize the empirical evidence on fear of large currency swings that characterizes exchange rate policy of many emerging market economies. Moreover, the model suggests that the effects of political pressures on the exchange rate are lower if the quality of institutions is higher. Empirical evidence for a large sample of emerging market economies is consistent with these findings.

Keywords: exporters and financial lobbies, exchange rate stability

JEL Classification: F3, D7

Suggested Citation

Faia, Ester and Giuliodori, Massimo and Ruta, Michele, Political Pressures and Exchange Rate Stability in Emerging Market Economies (May 2008). Journal of Applied Economics, Vol. 11, No. 1, pp. 1-32, May 2008, Available at SSRN: https://ssrn.com/abstract=1158588

Ester Faia

Goethe University Frankfurt ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Massimo Giuliodori

University of Amsterdam - Faculty of Economics & Econometrics (FEE) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Michele Ruta (Contact Author)

Economic Research Division, WTO ( email )

Rue de Lausanne 154
CH-1211 Geneva
Switzerland

HOME PAGE: http://www.iue.it/Personal/Fellows/MicheleRuta/Welcome.htm

Columbia Business School - Economics Department ( email )

420 West 118th Street
New York, NY 10027
United States

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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