The Partisan Reversal: Exchange Rate Policy in Closed and Open Economies

• In Event: Exchange Rates and Government Credibility Reconsidered

Abstract

This paper shows that political parties strongly influence exchange rate policy, and that rising international capital mobility has reversed which parties maintain overvalued exchange rates and which maintain undervalued exchange rates. We model exchange rate policy decisions as a function of the partisan orientation of government and the degree of international capital mobility. At low levels of capital mobility, an overvalued exchange rate redistributes income from capital to labor. As capital mobility rises, overvalued exchange rates become costlier for workers but more attractive to firms. We therefore hypothesize that left-wing parties, whose core constituent is labor, are more likely to overvalue the exchange rate at low levels of international capital mobility. Right-wing parties, representing business interests, are more likely to overvalue the exchange rate at high levels of capital mobility. Analyses of time-series cross-sectional data for the period of 1975-2017 support these hypotheses. The results indicate that globalization can have transformative effects on the relationship between partisanship and economic policy.

Authors

• Andrew Rys, Johns Hopkins University

• David A. Steinberg, Johns Hopkins University