Minority governments and exchange rate regimes: Examining evidence from 21 OECD countries, 1975-1999

Abstract:

We examine the impact of minority governments on the choice of exchange rate regime in advanced OECD democracies after the collapse of the Bretton Woods system. We demonstrate that leaders of minority governments had a lower political discount factor in office than majority governments across advanced OECD democracies and use that finding to motivate a model. The model predicts that leaders of minority governments had strong incentives to switch from a fixed to a floating exchange rate because of a lower discount factor in office. Results from Markov transition models estimated on de facto exchange rates adopted by OECD and West European OECD countries between 1975 and 1999 provide robust statistical support for the model’s prediction. We also briefly discuss how the findings presented in this paper have important implications for understanding the likelihood of expansion of Economic and Monetary Union (EMU) to new democracies in Central and Eastern Europe in the near future.