Abstract
Analyses of the political economy of exchange rate policy posit that firms and individuals in different sectors of the economy have distinct policy attitudes toward the level and stability of the exchange rate. Most such approaches hypothesize that internationally exposed firms prefer more stable currencies and that producers of tradables prefer a relatively depreciated real exchange rate. As sensible as such expectations may be, there are few direct empirical tests of them. This paper offers micro-level, cross-national evidence on sectoral attitudes about the exchange rate. Using firm-level data from the World Bank's World Business Environment Survey, we find systematic patterns linking sector of economic activity to exchange rate policy positions. Owners and managers of firms producing tradable goods prefer greater stability of the exchange rate: in countries with a floating currency, manufacturers are more likely to report that the exchange rate causes problems for their business. With respect to the level of the exchange rate, we find that tradables producers—particularly manufacturers and export producers—are more likely to be unhappy following an appreciation of the real exchange rate than are firms in nontradable sectors (services and construction). These findings confirm theoretical expectations about the relationship between economic position and currency policy preferences.
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Notes
Obviously, policymakers have a wide choice of regime, ranging from a completely free float to a variety of managed floats, degrees of fixity ranging from a target zone to a peg, and a currency board or dollarization. This discussion focuses on the extremes—hard pegs and pure floats—however, because the analysis of intermediate cases flows from the extremes, and the trade-offs described apply to the intermediate choices, albeit never as starkly as to the extremes.
Under most regimes a government must decide whether it prefers a relatively appreciated or relatively depreciated currency. Free floats are rare, and by the same token, countries that opt for a pegged regime always have the choice of abandoning the peg.
See Mundell (1961), McKinnon (1963), and Kenen (1969). A more recent survey is Tavlas (1994).
See for example, the empirical results in Frankel (1995), Rose (2000), Végh (1992), and Ghosh and others (1997).
For a discussion of the WBES project, see Batra, Kaufmann, and Stone (2003).
LYS include an “intermediate” category, which we omit from our analysis because we have no strong theoretical priors about business elites’ attitudes in these regimes.
We drop all firms identifying themselves as “Other.”
Respondents that indicated they were exporters were also asked to specify the percentage of exports to total sales. Unfortunately, most firms did not respond to this inquiry, and so we are constrained to use a dummy variable to indicate whether a firm exports or not.
The data are from the International Financial Statistics (IFS) and the Bank for International Settlements (BIS). The World Development Indicators provide data for Georgia, but coverage ends at 1998. Therefore, REER Appreciation for Georgia measures the percentage change in the real effective exchange rate between 1998 and 1997.
Government ownership is a dummy variable that takes the value of 1 if a respondent indicates state ownership. Firm size is an ordered response: 1=small (5–50 employees); 2=medium (51–500 employees); 3=large (>500 employees).
Similar effects (not reported) were obtained substituting the interactions of REER appreciation with exporter and tradables.
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Additional information
*J. Lawrence Broz is an associate professor in the Department of Political Science at the University of California, San Diego; Jeffry Frieden is a professor in the Department of Government at Harvard University; and Stephen Weymouth is a Ph.D. student in the Department of Political Science at the University of California, San Diego. The authors thank Justin Wolfers and Barry Eichengreen for helpful comments. They also thank participants at the IMF's Eighth Annual Jacques Polak Research Conference, Washington, November 15–16, 2007.