The political economy of exchange rate regime determination: Theory and evidence

The dissertation develops a positive theory of exchange rate regime determination in a small open economy. The exchange rate regime emerges as an outcome of repeated interaction between governments and their domestic and foreign creditors. The model integrates several broad aspects of monetary and fiscal policy as well as the political environment. The differences between de jure and de facto exchange rate regime flexibility are highlighted, while the latter definition of regime is adopted. The cross-section regression results for the 1980s and 1990s confirm the major implications of the model. The burden and composition of government debt are significant determinants of exchange rate regime choice. The higher the proportion of foreign to domestic debt, the more rigid the exchange rate regime tends to be. To the extent that a history of inflation persistence and the resulting loss of credibility leave little room for monetary policy to maneuver, governments try to re-establish confidence through maintaining a fixed exchange rate. Incentives to provide stimulus to a weak economy are likely to lead to a more flexible regime. Measures of political stability and accountability also enter the analysis significantly. Complementary to the regression analysis, a case study approach enhances the scope for studying how exchange regimes vary across time and different institutional settings. A historical perspective on exchange rate regime choice in Canada and Argentina is provided, along with a comparative study of regime preference in Hungary and the Czech Republic during transition towards a market economy in the 1990s.