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This chapter extends the analysis of the previous chapter to an open economy by introducing exchange rate policy; analyzing the complex relationships between exchange rate, fiscal, and monetary policies; and examining the ways in which capital flows complicate traditional analyses. Despite the greater complexities associated with open economy macroeconomics, the policy conclusions for a closed economy remain remarkably unaffected. While Keynesians and heterodox economists believe that government should actively intervene, conservatives remain skeptical about the desirability of such interventions. The objective of this chapter is to shed some light on how economists can come to such diverse views on economic policy. The first section examines the macroeconomic effects of exchange rates on employment, trade, inflation, aggregate demand, growth, and balance sheets. The second section examines the complex interactions between fiscal, monetary, and exchange rate policies in open economies with either fixed or flexible exchange rate regimes. This section also examines the effects of interest rates and exchange rates on capital flows in both crisis and non-crisis situations.

Seeks to understand why some member‐states of the European Community attempted, with eventual success, to extend supranational authority in the domain of monetary and exchange‐rate policy and to anticipate some of the probable consequences of such extension. It begins by analysing the beliefs that originally underpinned the attempt, concerning the perceived need to resolve the community tensions inherent in independent economic policy‐making. It then considers the economic, political and institutional dilemmas, and uncertainties likely to confront member‐states as economic integration proceeds. Concentrating on the issues of low growth and high unemployment, it assesses how far European Monetary Union is likely to provide a remedy, and whether it will be necessary or desirable to create a counterweight to the authority of the European Central Bank, and to create new supranational organizations in the domain of European macroeconomic governance.

This chapter develops the conditional preference theory, which contends that the preferences of powerful interest groups are the most important driver of exchange rate policy. Those preferences, however, are not fixed or constant, as is often assumed. Rather, preferences for undervalued exchange rates are influenced by a country's institutional context. After first providing some background information about exchange rate economics, the chapter develops the conditional preference theory in four main steps. First, it explains why powerful interest groups, defined as societal actors that control many power resources, influence government decisions regarding exchange rate levels. Second it examines interest groups' preferences. Third, it explains why institutions influence interest groups' preferences. The final step in the argument puts together the two main pieces of the story—power and preferences—to explain when exchange rates are most likely to be undervalued.

This chapter investigates the impact of interests and institutions on exchange rate policy with case studies of South Korea, Mexico, and Iran. It shows that Korean policymakers in the 1960s and 1970s used their control over labor and financial markets to increase industrialists' support for an undervalued exchange rate. Korea's powerful industrialists also provided crucial political backing for President Park's decision to maintain an undervalued exchange rate. Mexican exchange rate politics bears many similarities to Argentine exchange rate politics: Mexican industrialists frequently opposed undervalued exchange rates, and their preferences encouraged Mexican policymakers to overvalue the peso. Iran's weak manufacturing sector typically favored an undervalued exchange rate. Although they received their preferred exchange rate policy in the 1960s and 1970s, Iranian manufacturers had insufficient clout to prevent an overvalued exchange rate in the 1950s, 1980s, or 1990s.

China's undervalued exchange rate has affected the world economy in numerous ways and is among the most contentious issues in contemporary international politics. This chapter examines whether the conditional preference theory helps explain exchange rate politics in China between 1993 and 2009. It begins with an overview of China's political and economic system, describing the organization of the labor and financial system and the power of the manufacturing sector. It then examines how politics shaped exchange rate policy in China between 1993 and 2009. The third section summarizes key findings and explains how they shed light on the relationship between domestic politics and undervalued exchange rates more broadly. It is shows that lobbying by the powerful manufacturing sector is a major reason why China kept its exchange rate undervalued for most of the 1993–2009 period.

This chapter evaluates whether exchange rate overvaluation in Argentina follows the logic of the conditional preference theory. The first part documents the Argentine state's inability to control its labor and financial systems, and explains why the manufacturing sector should have high levels of influence over the country's exchange rate policies. The second half of the chapter examines the political dynamics of exchange policymaking in Argentina between 1966 and 2012. It is shown that Argentina's manufacturing sector has usually preferred an overvalued exchange rate to an undervalued one. There was one important exception to this general trend: between 2001 and 2005, when the country's economy was suffering from high degrees of excess capacity and business costs became disconnected from undervaluation as a result.

This introductory chapter begins with an overview of the dollarization debate, which essentially calls for the reevaluation of countries’ exchange rate policies. It argues that although dollarization has been effective in stopping high inflation, it has been less reliable in providing fiscal discipline and promoting flexible labour markets. Brief descriptions of the papers included in this volume are presented.

This concluding chapter reviews the evidence provided in chapters 2 through 5. The evidence confirms that preferences for undervalued exchange rates are context-dependent, and that powerful interest groups influence decisions about exchange rate policy. Together, these two pieces of evidence indicate that undervalued exchange rates are rare at least in part because they fail to receive solid support from powerful interest groups. The chapter suggests that the scholarly literature on political economy would benefit from reconceptualizing the relationship between interests and institutions, and paying more attention to how contextual factors shape preferences. It also discusses a key policy implication of the findings: the potential for certain types of institutional reforms to contribute to better exchange rate policies.

This introductory chapter sets out the book's purpose, which is to explain why a relatively small number of developing countries keep their exchange rates undervalued while many more overvalue their exchange rates. Using both quantitative data on over one hundred countries and detailed case studies of five developing countries, this book provides strong evidence in support of a domestic political explanation of undervalued exchange rates. The chapter then discusses the conditional preference theory, which argues that undervalued exchange rates are most likely when the manufacturing sector is powerful and the state controls labor and financial markets. It also considers the implications of the theory for our understanding of the global political economy. This is followed by an overview of the subsequent chapters.

This chapter uses two different cross-national quantitative datasets to address the following question: Why do some developing countries undervalue their exchange rates while others maintain overvalued exchange rates? First, it examines which countries are most likely to maintain undervalued exchange rates, using data on as many as one hundred twenty developing countries from 1975 to 2006. The data indicate that exchange rates are most undervalued when countries combine powerful industrial sectors with state control over labor and financial markets. Second, it analyzes survey data on about two thousand manufacturing firms from over fifty countries in the year 1999 to understand whether and when industrialists favor undervalued exchange rates. These analyses show that manufacturing firms are more supportive of undervalued exchange rates in countries with state-controlled labor and financial systems than they are in other conditions.

This chapter gives an overview of Latin American currency policy since the collapse of the Bretton Woods monetary order in the early 1970s and provides a statistical analysis of exchange rate choices. It starts with a reminder of the author's analytic expectations, especially as relevant to Latin America, and then goes on to give a historical background to the region's experience and provide a narrative analysis of regional currency policy developments, emphasizing special interest and electoral factors. First, it evaluates the impact of the sort of special interest pressures examined in the US and European cases. It presents evidence that reinforces the idea that internationally oriented economic actors favor a more stable currency. The second set of political factors is related to elections. The evidence seems clear that governments do indeed encourage or allow the currency to appreciate in the run-up to an election, and similarly delay going off a currency peg during that period.

This chapter sets forth a theoretical framework for the analysis of the politics of exchange rates. It relies on three factors—international exposure, tradability, and pass-through—to explain as much of currency policy preferences as possible. This can provide building blocks for a broader analysis of the politics of exchange rates. The chapter begins with a statement of the dependent variables of the study. It then presents the author's reasoning and the empirical expectations that flow from it. This is followed by a brief summary of other scholarly studies of the economics and politics of exchange rates in order to situate this study within the broader literature.

This introductory chapter begins with discussions of currency choices, currency trade-offs, politics of currency policy, currency policies in open and closed economies, and currency politics applied across time and space. It then sets out the book's purpose, which is to analyze the politics of exchange rates. The book has both theoretical and empirical ambitions. Theoretically, it focuses on identifying the distributionally motivated currency policy preferences of economic actors—firms, industries, and groups. Empirically, it evaluates the accuracy of its theoretical arguments in a variety of historical and geographic settings. From a historical perspective, it looks at the politics of the gold standard, particularly in the United States. In a more contemporary mode, it examines the political economy of the process of European monetary integration. It also analyzes the politics of Latin American currency policy over the past forty years.

This chapter studies how Norges Bank came to play a central, technical role in maintaining and defending a stable krone exchange rate during the years 1946–86. This role was reflected in how the bank advised on the basis of a loyal position to the fixed krone exchange rate regime and to binding international exchange rate cooperation. In 1978, Norway backed out of the European fixed exchange rate cooperation, and during 1976–86, the krone was devalued ten times. Even though Norges Bank officially came to contribute to both recommending and carrying out this policy, the policy defied the strong ideals and viewpoints of the organization. The exchange rate policy, and the problems it led to in relation to the central bank, caused the government, in the first half of the 1980s, to push Norges Bank completely aside when it came to the shaping of Norwegian exchange rate policy. Nevertheless, much of the policy was still shaped inside the walls of the institution.

This chapter examines the experience of Mexico with a floating exchange rate regime. It reviews Mexico's problematic transition to the floating exchange rate regime during 1994–95 and describe how monetary and exchange rate policy have been conducted under this regime. This chapter analyzes the behavior of inflation, exchange rates and other financial and real variables during the float and suggests that the floating exchange rate regime in Mexico has performed better than conventional wisdom would have led us to believe.

This chapter analyzes the process of European monetary integration, focusing on the decades that led up to the creation of the common currency. This is because this period is one in which, as in the gold standard era, national governments had to decide on their currency policy, and, again as in the gold standard period, there were major domestic political conflicts over this choice. The battles over exchange rate policy in Europe since the early 1970s were at the center of the broader process of European integration. The eventual adoption of the euro was perhaps the crowning achievement of prointegration forces, and both the process and result reflect the central realities of contemporary Europe's political economy.