Democratic institutions and exchange-rate commitments

Since the collapse of the Bretton Woods system, countries have been able to choose from a variety of exchange-rate arrangements. We argue that politic ians' incentives condition the choice of an exchange-rate arrangement. Thes e incentives reflect the configuration of domestic political institutions, particularly electoral and legislative institutions. In systems where the c ost of electoral defeat is high and electoral timing is exogenous, politici ans will be less willing to forgo their discretion over monetary policy wit h a fixed exchange rate. In systems where the costs of electoral defeat are low and electoral timing is endogenous, politicians are more likely to ado pt a fixed exchange-rate regime. Consequently, differences in domestic poli tical systems can help account for variations in the choice of exchange-rat e arrangements. We test this argument using constrained multinomial logit a nd binomial logit on a sample of twenty democracies over the period 1974-95 . Domestic political institutions have a significant effect on exchange-rat e regime choice, even after controlling for systemic, macroeconomic, and ot her political variables.