Currency Crises and Political Factors: Drawing Lessons from the EMS Experience

FEDEA Documento de Trabajo Working Paper No. 2004-04

31 Pages Posted: 14 Apr 2004

See all articles by Francisco Perez-Bermejo

Francisco Perez-Bermejo

Foundation for Applied Economic Research (FEDEA)

Simon Sosvilla-Rivero

UCM Institute for Economic Analysis

Date Written: March 2004

Abstract

This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an eclectic specification that enables us to explicitly incorporated political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the real exchange rate, the interest differentials and the central parity deviation would have negatively affected the duration of a given central parity, while credibility, the level of international reserves and the price level in the anchor country would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.

Keywords: Duration analysis, Political variables, Exchange rates, European Monetary System

JEL Classification: C41, D72, F31, F33

Suggested Citation

Perez-Bermejo, Francisco and Sosvilla-Rivero, Simon, Currency Crises and Political Factors: Drawing Lessons from the EMS Experience (March 2004). FEDEA Documento de Trabajo Working Paper No. 2004-04. Available at SSRN: https://ssrn.com/abstract=529642 or http://dx.doi.org/10.2139/ssrn.529642

Francisco Perez-Bermejo

Foundation for Applied Economic Research (FEDEA) ( email )

Jorge Juan 46
Madrid, 28001
Spain
+34 91 435 04 01 (Phone)
+34 91 577 95 75 (Fax)

Simon Sosvilla-Rivero (Contact Author)

UCM Institute for Economic Analysis ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

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