Understanding Exchange Rate Policy Announcements: A Political Economy Approach

Abstract

The stability of the international financial system depends on the consistency of announcements, beliefs, and actions by countries and international organizations like the IMF. This article considers the first element in this trinity and analyzes the incentives of a rational policy maker to announce a fixed or flexible exchange rate regime. In a cross-sectional analysis for the 1990s, I find that countries with a non-functioning legal system, a low degree of the rule of law, high expropriation risk, low infrastructure quality and similar characteristics are more likely to announce fixed exchange rates. This result is consistent with a theoretical argument about announcing a fixed regime as a signal of “goodness” to the international community.