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Sustaining fixed rates: The political economy of currency pegs in Latin America

Government exchange rate regime choice is constrained by both political and economic factors. One political factor is the role of special interests: the larger the tradable sectors exposed to international competition, the less likely is the maintenance of a fixed exchange rate regime. Another political factor is electoral: as an election approaches, the probability of the maintenance of a fixed exchange rate increases. We test these arguments with hazard models to analyze the duration dependence of Latin American exchange rate arrangements from 1960 to 1999. We find substantial empirical evidence for these propositions. Results are robust to the inclusion of a variety of other economic and political variables, to different time and country samples, and to different definitions of regime arrangement. Controlling for economic factors, a one percentage point increase in the size of the manufacturing sector is associated with a reduction of six months in the longevity of a country’s currency peg. An im pending election increases the conditional likelihood of staying on a peg by about 8 percent, while the aftershock of an election conversely increases the conditional probability of going off a peg by 4 percent.

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Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): VIII (2005)
Issue (Month): (November)
Pages: 203-225

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Handle: RePEc:cem:jaecon:v:8:y:2005:n:2:p:203-225
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  1. Ernesto H. Stein & Jeffry Frieden, 2000. "The Political Economy of Exchange Rate Policy in Latin America: An Analytical Overview," Research Department Publications 3118, Inter-American Development Bank, Research Department.
  2. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
  3. Marco Bonomo & Cristina Terra, 2005. "Elections And Exchange Rate Policy Cycles," Economics and Politics, Wiley Blackwell, vol. 17, pages 151-176, 07.
  4. Kiefer, Nicholas M, 1988. "Economic Duration Data and Hazard Functions," Journal of Economic Literature, American Economic Association, vol. 26(2), pages 646-79, June.
  5. Barry Eichengreen & Jeffry Frieden, 1993. "The Political Economy Of European Monetary Unification: An Analytical Introduction," Economics and Politics, Wiley Blackwell, vol. 5(2), pages 85-104, 07.
  6. Jeffrey A. Frankel & Andrew K. Rose, 1996. "The Endogeneity of the Optimum Currency Area Criteria," NBER Working Papers 5700, National Bureau of Economic Research, Inc.
  7. S. Brock Blomberg & Gregory D. Hess, 1996. "Politics and exchange rate forecasts," Research Working Paper 96-02, Federal Reserve Bank of Kansas City.
  8. Michael W. Klein & Nancy P. Marion, 1994. "Explaining the Duration of Exchange-Rate Pegs," NBER Working Papers 4651, National Bureau of Economic Research, Inc.
  9. Vladimir Klyuev, 2001. "A Model of Exchange Rate Regime Choice in the Transitional Economies of Central and Eastern Europe," IMF Working Papers 01/140, International Monetary Fund.
  10. Ernesto H. Stein & Jeffry Frieden & Piero Ghezzi, 2000. "Politics and Exchange Rates: A Cross-Country Approach to Latin America," Research Department Publications 3119, Inter-American Development Bank, Research Department.
  11. Collins, Susan M., 1996. "On becoming more flexible: Exchange rate regimes in Latin America and the Caribbean," Journal of Development Economics, Elsevier, vol. 51(1), pages 117-138, October.
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  13. Frieden, Jeffry A., 1997. "Monetary Populism in Nineteenth-Century America: An Open Economy Interpretation," The Journal of Economic History, Cambridge University Press, vol. 57(02), pages 367-395, June.
  14. C. Randall Henning, 1994. "Currencies and Politics in the United States, Germany, and Japan," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 15, December.
  15. Stephan Haggard, 2000. "Political Economy of the Asian Financial Crisis, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 107, December.
  16. Bernhard, William & Leblang, David, 2002. "Political Parties and Monetary Commitments," International Organization, Cambridge University Press, vol. 56(04), pages 803-830, September.
  17. Rogoff, Kenneth & Sibert, Anne, 1988. "Elections and Macroeconomic Policy Cycles," Review of Economic Studies, Wiley Blackwell, vol. 55(1), pages 1-16, January.
  18. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  19. Eichengreen, Barry, 1993. "European Monetary Unification," Journal of Economic Literature, American Economic Association, vol. 31(3), pages 1321-57, September.
  20. Broz, J. Lawrence, 2002. "Political System Transparency and Monetary Commitment Regimes," International Organization, Cambridge University Press, vol. 56(04), pages 861-887, September.
  21. Bernhard, William & Leblang, David, 1999. "Democratic Institutions and Exchange-rate Commitments," International Organization, Cambridge University Press, vol. 53(01), pages 71-97, December.
  22. Ernesto H. Stein & Natalia Salazar & Roberto Steiner & Eugenio Díaz-Bonilla & Marco Bonomo & Juan C. Jaramillo & Hector E. Schamis & Alberto Pascó-Front & Piero Ghezzi & Maria Cristina Terra & José De, 2001. "The Currency Game: Exchange Rate Politics in Latin America," IDB Publications (Books), Inter-American Development Bank, number 77398 edited by Ernesto H. Stein & Jeffry Frieden.
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