The Political Economy of Foreign Exchange Interventions

Exchange rate movements have implications for the purchasing power of residents or voters. Given that the exchange rate is often seen as a barometer of government performance, there could be strong incentives to influence exchange rate valuation during elections. This paper investigates whether political economy factors affect Foreign Exchange Intervention (FXI) policy across countries. It investigates whether central banks tend to implement FX sales, leaning against depreciations, during electoral periods in a sample of 28 countries including both advanced (AEs) and emerging (EMs) economies over the period 2000-2019. The results show that EMs with competitive elections tend to implement more and larger FX sales in pre-electoral period, compared to post-election period, given their political popularity. Further, this result is driven by countries where political pressures on central bank governors are more prevalent. Furthermore, the paper also finds that monetary policy transparency has the potential to mitigate this politically driven FXI during electoral period. Finally, the paper discusses policy implications given that politically motivated FX sales could hamper the ability of central banks to effectively respond to large shocks.