Faculty of Economics and Business Administration Publications Database

Political Pressures and Exchange Rate Stability in Emerging Market Economies

Giulodori, Massimo
Ruta, Michele
Volume: 11
Number: 1
Pages: 1 - 32
Month: May
ISSN-Print: 1514-0326
Link External Source: Online Version
Year: 2008
Keywords: Public-private sector cooperation; Economics; Monetary Policy, Foreign exchange rate; Interest rate parity theorem; Emerging markets; Foreign investments
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 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.