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Policy Responses to Balance-of-Payments Crises: The Role of Elections

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Abstract

Governments have a number of policy tools that can be used to address pressure on the balance of payments, threatening an undesirable decline in the relative value of the national currency. They can: (1) sell reserves, (2) raise interest rates, (3) impose capital controls, (4) apply trade restrictions, or (5) depreciate the currency. While researchers typically analyze these policies in isolation from one another, we treat them as a menu of options available to election-minded politicians. We analyze the use of these five policy responses to payments difficulties for a large sample of countries since the early 1970s. We argue that governments try to minimize political costs by adopting less transparent policies first and only moving to more visible policies as necessary, delaying the most visible and politically costly policies until after elections. The evidence is consistent with these claims: governments are more likely to draw down reserves and impose capital controls before other options. If these policies do not succeed, they tend to raise interest rates. If further action is needed, they delay devaluations and trade protection until after elections.

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Notes

  1. Sales of foreign reserves are constrained by the size of the country’s accumulated stock.

  2. Between December 2008 and April 2009, Angola, Argentina, Armenia, Belarus, Fiji, Kazakhstan, Russia, Singapore, Switzerland, Ukraine, and Vietnam either officially devalued or experienced large depreciations in their currencies.

  3. The major countries that imposed import restrictions during this period were: France (1954–58, 1968), Denmark (1955–56, 1971–72), Sweden (1959–60), Spain (1958–59, 1965–71), Canada (1962–63), the United Kingdom (1964–66, 1968–70), Germany (1968), the United States (1971), and Italy (1974–75).

  4. The trilemma–that fixed exchange rates and open capital markets mean a loss of monetary policy autonomy–is explored empirically by Aizenman et al. (2010) and Obstfeld et al. (2005).

  5. For a survey of the exchange-rate policy literature, see Broz and Frieden (2008). Rodrik (1995) provides a review of the trade policy literature.

  6. We do not consider fiscal austerity and structural reforms in this paper because these policies tend to be more difficult to implement in the short-run context of a payments crisis. However, an analysis of medium-term responses to crises would include these policies in the menu of adjustment options open to policymakers.

  7. For reviews, see Franzese (2002) and Drazen (2000).

  8. See Klein 2012 for the latest word.

  9. A key finding of the economic voting literature is that when the economy prospers voters reward the incumbent government, but when the economy falters they punish incumbents (Lewis-Beck and Stegmaier 2000; Hellwig 2010).

  10. For a welfare analysis of import surcharges, see Congressional Budget Office (1985).

  11. In 2006, the WTO General Council decided to make public all official documents issued under the General Agreement on Tariffs and Trade (GATT).

  12. Departing from the control variables used by Forbes and Klein (2015), we also estimated models that included a dummy variable for being under an International Monetary Fund (IMF) Standby Arrangement. The variable was not significant and our core explanatory variables retained their significance and substantive effects.

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Authors and Affiliations

  1. Department of Political Science, University of California, San Diego, La Jolla, CA, 92093, USA

    J. Lawrence Broz & Maya J. Duru

  2. Department of Government, Harvard University, Cambridge, MA, USA

    Jeffry A. Frieden

Authors
  1. J. Lawrence Broz
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  2. Maya J. Duru
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  3. Jeffry A. Frieden
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Corresponding author

Correspondence to Jeffry A. Frieden.

Additional information

This paper was presented at the 2015 International Political Economy Society (IPES) conference, December 13–14, 2015, Stanford University. We thank conference participants for comments and suggestions.

Appendix

Appendix

Table 3.

Table 3 Variable Definitions and Sources
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Table 4.

Table 4 List of Trade Protection Cases (1975–2010)
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Table 5.

Table 5 Policy Changes, 1975–2010
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Broz, J.L., Duru, M.J. & Frieden, J.A. Policy Responses to Balance-of-Payments Crises: The Role of Elections. Open Econ Rev 27, 207–227 (2016). https://doi.org/10.1007/s11079-016-9387-y

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