Why are realignments postponed? A model of exchange rate revisions with opportunistic governments

In: The Manchester School, Band 72, Heft 3, S. 298-316

Abstract

In this paper we investigate the consequences of elections on the willingness of office‐motivated governments to defend a pre‐announced parity in the presence of output shocks in a fixed exchange rate regime with an escape clause. Knowing that voters rationally interpret realignments as a sign of incompetence, incumbents refrain from realigning before elections. They can do so either when they are competent or when shocks are small enough. Realignments are therefore more likely and output is less volatile on the morrow than on the eve of elections. The welfare impact of elections is ambiguous.