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Why are some policymakers able to adjust their policies in response to deteriorating economic conditions, while other policymakers delay adjustment as long as possible, a policy path that typically ends with an economic crisis? This paper examines this question by focusing on the area of exchange-rate policy, where delayed devaluations frequently end with a currency crisis. I argue that distributional concerns can create strong incentives for policymakers to delay adjustment as long as possible. These incentives are particularly strong when politically influential actors are vulnerable to exchange-rate adjustment and exchange-rate stability can be maintained without a tightening of monetary policy. Since delaying adjustment allows the misalignment to accumulate, however, the costs of adjustment rise and further decrease political incentives to reform. This can cause a negative spiral of delayed reform that is exacerbated by institutions that make adjustment more politically costly. When market pressures escalate, agents reevaluate their policy preferences based on the trade-off between their vulnerability to depreciation and their vulnerability to interest-rate increases. When aversion to internal adjustment is high, a currency crash becomes the most likely outcome. The paper compares the build-up and management of the Asian Financial Crisis to the current financial turmoil and currency crises occurring in Iceland, Hungary and Latvia. [ABSTRACT FROM AUTHOR]

This paper presents and tests a new approach for determining exchange-rate level preferences, which takes the effects of internationally open capital markets into account, with survey data covering 5467 firms in 49 countries. ..PAT.-Unpublished Manuscript [ABSTRACT FROM AUTHOR]

The article examines how a government responds to a speculative currency attack. It discusses the influence of the regime type on the propensity of a government to engage in an exchange rate defense. It argues that autocratic governments are more capable to defend their exchange rate than democratic governments. It concludes that democratic governments seem to comply with pressure from the population when economic conditions deteriorate too much while autocratic governments tend to ignore the pressure.

How do governments react to speculative attacks? Since the decision whether to devalue or to defend is inherently political, the existing economic literature has not been able to convincingly answer this question. Following recent research focusing on political explanations, we argue that authoritarian governments are committed more strongly to a fixed exchange rate than democratic governments for two reasons. First, democratic governments are more hesitant to impose the costs of a defense on their population because this may seriously harm their reelection chances. Second, fixing the exchange rate is an important commitment device to gain anti-inflationary credibility for authoritarian governments because authoritarian governments cannot credibly delegate monetary policy to an independent central bank. We test our hypothesis for a sample of more than 164 speculative attacks in 38 developing and transition countries from 1970 to 2003 using logistic regression analysis. The analysis shows that the probability of a successful currency defense is significantly higher in autocratic than in democratic regimes. A more detailed analysis using a sequential model shows that autocratic and democratic governments do not differ with respect to their decision whether to mount a defense in the first place. Instead, democratic governments are significantly more likely to abort an initial attempt to defend the exchange rate within the 5 months following upon the initial attack. The findings suggest that the importance of political institutions becomes apparent only once the country starts to experience the economic consequences of a defense and popular pressure to devalue increases. ..PAT.-Conference Proceeding [ABSTRACT FROM AUTHOR]

This paper argues that distributional concerns and discounting can induce time-inconsistent policy preferences among individuals and firms in the area of exchange rate politics. The resulting interest-group pressure to maintain exchange-rate stability creates incentives for policymakers to delay needed adjustments of the exchange rate. When the institutional environment encourages such behavior, this can result in an overvaluation of the exchange rate. I test this argument for a cross-section of 56 countries. The analysis examines whether higher shares of firms with time-inconsistent policy preferences, measured as the proportion of firms indicating such preferences in a cross-national survey, result in more overvalued exchange rates. I then analyze how institutions such as central bank independence and the electoral cycle interact with these preferences to mitigate or exacerbate the incentives for delayed exchange rate adjustments. The results suggest that popular pressure to maintain exchange rate stability is an important driver of overvaluation. This effect is exacerbated when elections are close. Central bank independence, however, mitigates these pressures only to a very small degree. ..PAT.-Unpublished Manuscript [ABSTRACT FROM AUTHOR]

Exchange rate policy preferences do not just originate in the effects of exchange rate policy but are intricately linked to monetary policy as well. Based on the trade-off between exchange rate and interest rate stability, this paper develops predictions about which socioeconomic groups are likely to prefer a depreciation, and which groups prefer that the present exchange rate level be maintained. It develops a new approach that considers private sector vulnerabilities to exchange rate and interest rate changes, as well as the implications for interest groups' competitiveness and their balance sheets. It argues that in periods of exchange rate tranquility, exchange rate policy is purely framed in terms of depreciation or appreciation effects. Only when pressure intensifies, they increasingly weigh their vulnerability to interest-rate increases against their depreciation vulnerability. In this case, high interest-rate exposure can result in a re-assessment of a group's preferred policy response, leading groups that initially preferred exchange rate stability to favor depreciation. Comparative case studies of speculative attacks on the currencies of Hong Kong, Korea, Thailand, and Taiwan support the argument's empirical implications. The case studies show that policymakers maintained exchange rate stability when the private sector's vulnerability to depreciation was high. However, when pressure intensified, exchange rates were subsequently depreciated in countries, where interest group vulnerabilities to a monetary tightening exceeded the potential costs of depreciation. ..PAT.-Unpublished Manuscript [ABSTRACT FROM AUTHOR]

This paper investigates how electoral timing influences policymakers? responses to currency crises. Previous empirical research has shown that elections significantly influence both the probability that a currency crisis emerges and the government?s policy responses to such crises. However, this research has not put forward a causal mechanism underlying these empirical findings. This paper addresses this lack of theoretical research and presents a political business cycle model on exchange rate policy, in which incumbents face a tradeoff between their wish to signal competence and the high cost of exchange rate defenses in response to currency crises. The model predicts that competent incumbents are more likely to defend in response to crises occurring before elections, while incompetent policymakers always devalue. Attacks occurring after elections are predicted to result in devaluations for all types of policymakers. Several empirical implications are derived from the model and are tested for a sample of 86 developing and developed countries for the time period 1970-2003. The results support the predictions of the model and show that 1) devaluation is more likely when attacks occur shortly after elections, 2) incumbents who defend their exchange rate before elections have a higher probability of being re-elected, and 3) policymakers are more likely to devalue as the intensity of the crisis increases. ..PAT.-Conference Proceeding [ABSTRACT FROM AUTHOR]