The Political Economy of Exchange Rate Regimes in Transition Economies

Abstract

We show that political economy factors play an important role in shaping the exchange rate policies of transition economies. We argue, among other things, that tradables producers prefer a floating rate to allow active exchange rate policy to affect their competitiveness, while internationally exposed sectors prefer a fixed rate to provide currency stability. We carry out a quantitative analysis of the de facto exchange rate behavior of 21 countries over the period 1992-2004. We find support for our arguments, along with some counter-intuitive results, for example associating democracy with a pegged currency and trade concentration with a floating currency. Our empirical results serve as the basis for predictions regarding the adoption of the euro in the EU accession countries and other countries in Central and Eastern Europe.

Keywords: Political economy, Exchange rate regimes, Transition economies, EMU, euro

JEL Classification: F31, F33