Democracy and Markets: The Case of Exchange Rates

Abstract

In this Working Paper, John Freeman, Jude Hays-both from the University of Minnesota-and Helmut Stix, an economist in the Economic Studies Division of the Oesterreichische Nationalbank study the impact of political information on exchange rates. In this interdisciplinary approach the authors combine theoretical results from the field of political science with those of economics to develop stylized facts about the impact of democratic institutions on economic equilibration. The authors develop several competing propositions about how political equilibration affects currency markets. Then these propositions are tested by means of a Markov switching model with time-varying transition probabilities which are governed by political information. The political variables used are government approval, the probability of government dissolution, the probability of government reelection and a measure of electoral uncertainty based on the concept of entropy. In general, the results show that information about electoral outcomes and opinion polls about chief executive performance do affect exchange rates. Also, there is some evidence that political effects are weaker in countries with proportional representation electoral systems than in countries with majority-plurality systems.

International institutions and market expectations: Stock price responses to the WTO ruling on the 2002 U.S. steel tariffs

“…This argument is supported by the empirical analysis of Pantzalis et al (2000). My argument is that the Freeman et al (2000) critique strengthens the argument for using equity indexes as a proxy for expectations of future economic performance. That is, political events that have a positive impact on stock markets are events that should have a positive long run impact on the economy.…”

“…31 Freeman et al (2000) argue that political institutions mitigate the impact of political information on financial markets. They argue that complex coalition politics and weak central banks limit the financial markets' ability to react and adjust to political events.…”

Estimating the Cost of Social-Democratic Government by Regression-Discontinuity Analysis of Close Elections

“…If the analysis is sensitive to important institutional differences across countries, this will not be too much of a problem. In fact, a null result could be turned into an institutionally rich finding such as markets react strongly to left-wing governments in countries with majoritarian electoral institutions but not to the election of left-wing governments in countries with proportional representation electoral systems (Freeman, Hays, and Stix 2000). Again, the reason for pooling is the small number of observations, but this problem becomes less serious as the number of close elections grows.…”

Endogenous changes in the exchange rate regime: A bureaucratic incentive model

“…See, among the numerous studies, Stockman (2000), Kenen (2000), Nilsson and Nilsson (2000), Fischer (2001). While the endogeneity of observed regime switches was recognized to a certain degree (e.g., Savvides, 1990;Bordo & Kydland, 1995;Collins, 1996;Edwards, 1996;Freeman et al, 2000;Fischer, 2001), along with the optimum currency area literature (see de Grauwe (1994) for surveys), they generally can be viewed as, phrased in de Kock and Grilli (1993, p. 347), a certain "result of incompatible monetary and exchange rate policies," thus virtually within the public interest model framework. 2.…”