Interests Or Expectations?: A Political Economy Model Of The Credibility Of Exchange Rate Agreements.

This contribution seeks to explain why a country commits itself to fix its exchange rate, and why, at a certain point, the credibility of this commitment may fade triggering the rational expectations of the financial markets to re-orient towards a realignment of the exchange rate, eventually producing speculative attacks.Thus, the following research question will be addressed:Why does a government decide to commit itself to fixed exchange rates? On what is the credibility of this commitment based? Why and when do the markets decide to bet on the lack of credibility of a similar commitment? In this work it is argued that the markets, in deciding whether to attack a currency peg or not, evaluate a wide range of factors, including socio-political and structural ones. In particular, the credibility of an exchange rate agreement, and, therefore, markets’ expectations about devaluation, are crucially depending on the behaviour and interests of socio-economic actors and interests groups. The main hypothesis to be tested is that an exchange rate peg credibility and resilience to a speculative attack increases, when it receives support from socio-economic groups. Secondly, this effect is greater when the support comes from groups to whom the government can be considered more sensitive. In particular, this research investigates the cases of Italy and UK permanence within the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) between its establishment in 1978 and its end in December 1998 just before the entry in operation of EMU. The analysis is carried out following the literature on speculative attacks (Eichengreen, Rose and Wyplosz, 1995). ..PAT.-Unpublished Manuscript [ABSTRACT FROM AUTHOR]