Real Exchange Rate Cycles Around Elections

Abstract

We develop the implications of devaluation cycles for real exchange rates in a two-sector small open economy with a cash-in-advance constraint. Policy-makers are office-motivated politicians. Voters have incomplete information on the competence and the opportunism of incumbents. Devaluation acts like a tax, and is politically costly because it can signal the government is incompetent. This provides incumbents an incentive to postpone devaluations, and can lead to an overvalued exchange rate before elections. We compare the implied cycle of appreciated/depreciated exchange rates with empirical evidence around elections from Latin America. Copyright Blackwell Publishing Ltd 2005.

Wall Street and Elections in Latin American Emerging Economies

“…This pattern is confirmed by research studying the impact of presidential elections on capital-market variables. A variety of papers find that depreciations of the nominal and real exchange rates occur in the months succeeding the presidential elections (Bonomo and Terra, 2005;Frieden et al, 2001;Stein et al, 2005). As noted by these authors, different causes could explain depreciations of the exchange rate after presidential elections.…”

“…More generally, in order to determine the behaviour of capital markets' strategists and analysts during electoral periods, we calculate the average of the recommendations given by investment banks during nine months prior to and following presidential elections (0 being the election date). We apply a similar methodology to that of Stein et al (2004) and Stein et al (2005) for the case of the nominal and real exchange rates respectively. variables indicating three, two and one month prior to elections are negatively and statistically significant at 1 per cent.…”

“…First, exchange-rate adjustments tend to be postponed as long as possible. Outgoing presidents avoid devaluing in the months prior to elections in order to limit the damage to their electoral chances or those of their party's candidate (Stein et al, 2005). Indeed, Blomberg et al (2005) argue that the probability of abandoning fixed exchange rates is small prior to elections, and large following them.…”

“…In order to determine whether candidates with non economic platforms have a high likelihood of being elected, we define a dummy variable equal to 1 if a presidential race is between "economically credible candidates". In order to define competition during elections we use the methodology elaborated by Stein et al (2005): we call an election competitive if the difference between votes of first and second presidential candidates is less than 15 percentage points. This variable equals 1 in presidential elections in which there is a "non economically credible candidate" running, or if he obtained a large majority (higher than 15 percentage points) of votes 10 .…”

Electoral Cycles in International Reserves: Evidence from Latin America and the OECD

“…1 Nominal devaluations translate into depreciations of the real exchange rate after elections (Stein, Streb, and Piero Ghezzi 2005). Rodolfo Cermeño, Robin Grier, and Kevin Grier (2010) point out that, in contrast to the significant post-electoral depreciation of the real exchange rate, no significant pre-electoral effects have been detected in cross-country panels of LatinAmerican countries.…”