Policy choices in tough times: The case of democratization and currency defense

Abstract

Do policymakers under financial and political distress make undesirable policy choices? This paper attempts to answer this question by studying the relationship between democratization and currency devaluation under speculative pressures. The central argument is that young democracies exhibit relatively high probabilities of succumbing to speculative attacks, as the political cost of economic adjustment needed for defense is relatively high for these nascent regimes. The paper further contends that this relationship is stronger when the regime can mobilize fewer resources to defend their currencies. To test these arguments, this paper uses monthly data for 117 countries from 1975 to 2008. The results from statistical analysis provide corroborative evidence for these arguments.

Currency returns during democratic transition: evidence from Tunisia

“…Yet, in the first quarter of the year 2014, the value of the dinar dropped in large part due to the central bank's decision to reduce intervention and allow a controlled fall of the dinar. This decision is in line with the finding of Son (2015) in that, governments' decisions, during democratic transitions, lead to currency devaluation. As a result, during the third year of the democratic transition process, the TND depreciated from 2.17 against the euro to 2.30 and from 1.57 to 1.71 against the US dollar.…”

“…Indeed, this explains our findings at post-event periods in that positive ARs are associated with uncertainty resolution (third and fourth elections), and negative CARs are associated with higher uncertainty elections (first and second elections). Fourth, on the relationship between domestic currency returns and the Tunisian democratic transition, we find results that are in line with those of Son and Krieckhaus (2016) and Son's (2015) work. While the aforementioned studies investigated the common relationship between democratic transitions and the exchange rate markets, this paper contributes to the literature and intensifies its scope of findings by employing an event study analysis.…”

“…However, governments' decisions, especially under elections and political change factors, may lead to currency devaluation. Son (2015) confirmed that young democracies are more likely to devalue their currencies compared to autocratic and democratic regimes. In a subsequent study, Son and Krieckhaus (2016) pointed out that existing research has explored the impact of democracy on currency markets and found no significant effect.…”

Constraints, competition, and competitiveness: explaining the non-linear effect of democratization on political budget cycles

“…Rather, it is the non-linear, non-deterministic process toward it, which introduces new political incentives and institutional constraints, often in sequence, not simultaneously, and sometimes with countervailing effects. This, in turn, gives democratizing regimes specific characteristics – a fact that has been under-appreciated in the literature (a notable exception is Son, 2016). In this article, we seek to uncover these characteristics in the context of political budget cycles (PBCs).…”

Transparency and currency crises

“…Many studies focus on economic variables, including macroeconomic and financial fundamentals, as determinants of currency crises (e.g., Frankel & Rose, 1996;Kaminsky, Lizondo, & Reinhart, 1998;Kaminsky & Reinhart, 1999). A smaller number of studies document the effect of political variables, such as political regime type (Steinberg, Koesel, & Thompson, 2015), democratization (Hays, Freeman, & Nesseth, 2003;Son, 2016), types of political institutions (Leblang & Satyanath, 2006;MacIntyre, 2001;Walter, 2009), and amount of political instability (Eichengreen, Rose, & Wyplosz, 1995;Leblang & Satyanath, 2006.…”