Working Paper: NBER ID: w4651
Authors: Michael W. Klein; Nancy P. Marion
Abstract: This paper is a theoretical and empirical investigation into the duration of exchange-rate pegs. The theoretical model considers a policy-maker who must trade off the economic costs of real exchange- rate misalignment against the political cost of realignment. The optimal time to spend on a peg is derived and factors that influence peg duration are identified. The predictions of the model are tested using logit analysis with a data set of exchange-rate pegs for sixteen Latin American countries and Jamaica during the 1957-1991 period. We find that the real exchange rate is a significant determinant of the likelihood of a devaluation. Structural variables, such as the openness of the economy and its geographical trade concentration, also significantly affect the likelihood of a devaluation. Finally, political events that change the political cost of realignment, such as regular and irregular executive transfers, are empirically important determinants of the likelihood of a devaluation.
Keywords: exchange rate pegs; duration; logit analysis; political costs; economic costs
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real exchange rate (F31) | likelihood of devaluation (F31) |
| economic openness (F43) | likelihood of devaluation (F31) |
| geographical trade concentration (R12) | likelihood of devaluation (F31) |
| political events (D72) | likelihood of devaluation (F31) |