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Fiscal Discipline and Exchange Rates: Does Politics Matter?
Author:
João Tovar Jalles
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Mr. Carlos Mulas-Granados null

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José Tavares null

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Series:
IMF Working Papers
Volume/Issue:
Volume 2016: Issue 230
Language:
English
Publication Date:
17 Nov 2016
DOI:
https://doi.org/10.5089/9781475555769.001
ISBN:
9781475555769
ISSN:
1018-5941
Pages:
30
Keywords:
WP; fiscal policy; dependent variable; Fiscal discipline; Deficit; Political Economy; Exchange Rates; disciplines policymaker; target exchange rate; constant term; exchange rate volatility; government coalition structure; time effect; section VI; section VII; government transfer; fiscal policy outcome; section III; Eurozone country; Exchange rate arrangements; Conventional peg; Government asset and liability management; Exchange rate flexibility; Africa; Caribbean
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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We look at the effect of exchange rate regimes on fiscal discipline, taking into account the effect of underlying political conditions. We present a model where strong politics (defined as policymakers facing longer political horizon and higher cohesion) are associated with better fiscal performance, but fixed exchange rates may revert this result and lead to less fiscal discipline. We confirm these hypotheses through regression analysis performed on a panel sample covering 79 countries from 1975 to 2012. Our empirical results also show that the positive effect of strong politics on fiscal discipline is not enough to counter the negative impact of being at/moving to fixed exchange rates. Finally, we use the synthetic control method to illustrate how the transition from flexible to fully fixed exchange rate under the Euro impacted negatively fiscal discipline in European countries. Our results are robust to a number of important sensitivity checks, including different estimators, alternative proxies for fiscal discipline, and sub-sample analysis.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund