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
Date Written: May 2008
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: Suggested Citation