The Political Economy of Institutional Quality and Monetary Policy

Abstract

A vibrant body of research analyzes the impact of domestic political institutions on choice of exchange-rate regime. While most of this work focuses on regime type, I examine the relationship between institutional quality and monetary policy. I empirically assess two strands of theoretical work that address the policy side of the equation: an extension of the logic underlying the autocracy-democracy divide, and the underappreciated Huang-Wei (2006) model. I find little consistent evidence of a link between weak institutions and choice of monetary anchor, although institutional quality is inversely related to inflation, an effect that persists when accounting for exchange-rate pegs and central bank independence. I also examine the effects of weak institutions on private-sector inflation concerns, finding that (perceived) weak institutions increase inflation concerns.

Keywords: Institutions, Monetary Policy, Firm-level Survey, Inflation

JEL Classification: E02, E42, E52, F50