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Democracy and Markets: The Case of Exchange Rates

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Abstract

The relationships between the workings of democratic institutions and currency markets are studied. Several competing propositions about how political (re)equilibration affects currency markets are derived and tested. The results support the view that democratic politics affects currency markets. Expectations and uncertainty about electoral outcomes and government survival affect the probability of switching between currency market equilibria. Additionally, opinion polls about chief executive performance have a direct effect on the probabilities of switches between currency regimes suggesting that these polls cause currency traders to revise their expectations about the stability of governments and (or) the contents of public policies. Electoral institutions mitigate the impact of politics on currency market equilibria. Political effects are weaker in countries with proportional representation electoral systems than in countries with majority-plurality systems. There is less evidence that central bank independence, consensual-corporatist systems, or "political coherency" reduces the effect of politics on currency markets.

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  • John R. Freeman & Jude C. Hays & Helmut Stix, 1999. "Democracy and Markets: The Case of Exchange Rates," Working Papers 39, Oesterreichische Nationalbank (Austrian Central Bank).
    • Handle: RePEc:onb:oenbwp:39
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    2. Daniel MITCHELL RESTREPO, 2006. "Forecasting the Colombian Exchange Rate: Capital Adjustments and Politics vs. Traditional IRP, Trade Adjustments and Random Walk Frameworks," Archivos de Economía 11228, Departamento Nacional de Planeación.
    3. Iljoong Kim & Inbae Kim, 2005. "Endogenous changes in the exchange rate regime: A bureaucratic incentive model," Public Choice, Springer, vol. 125(3), pages 339-361, December.
    4. Fratzscher, Marcel & Stracca, Livio, 2009. "Does it pay to have the euro? Italy’s politics and financial markets under the lira and the euro," Working Paper Series 1064, European Central Bank.
    5. Nathan Jensen, 2007. "International institutions and market expectations: Stock price responses to the WTO ruling on the 2002 U.S. steel tariffs," The Review of International Organizations, Springer, vol. 2(3), pages 261-280, September.
    6. Civilize, Sireethorn & Wongchoti, Udomsak & Young, Martin, 2015. "Military regimes and stock market performance," Emerging Markets Review, Elsevier, vol. 22(C), pages 76-95.
    7. Marcel Fratzscher & Livio Stracca, 2009. "Does It Pay to Have the Euro? Italy's Troubled Politics and Financial Markets under the Lira and the Euro," International Finance, Wiley Blackwell, vol. 12(1), pages 1-31, May.
    8. Nathan M Jensen, 2005. "Measuring Risk: Political Risk Insurance Premiums and Domestic Political Institutions," International Finance 0512002, University Library of Munich, Germany.

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