Currency Crises and Political Factors: Drawing Lessons from the EMS Experience
FEDEA Documento de Trabajo Working Paper No. 2004-04
31 Pages Posted: 14 Apr 2004
Date Written: March 2004
Abstract
This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an eclectic specification that enables us to explicitly incorporated political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the real exchange rate, the interest differentials and the central parity deviation would have negatively affected the duration of a given central parity, while credibility, the level of international reserves and the price level in the anchor country would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.
Keywords: Duration analysis, Political variables, Exchange rates, European Monetary System
JEL Classification: C41, D72, F31, F33
Suggested Citation: Suggested Citation
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