Agency under capital mobility: Domestic political institutions and the policy autonomy/exchange rate stability tradeoff

Under capital mobility, states must choose between an autonomous monetary policy with currency variability versus stabilizing exchange rates with the sacrifice of policy autonomy. The central research question asks what factors lead the advanced industrial democracies to choose stable exchange rates and what factors lead them instead towards an autonomous monetary policy in the post-Bretton Woods era characterized by international capital mobility.; I first show how a government's choice for/against monetary policy autonomy or exchange rate stability can be seen in its fiscal/monetary policy mix choice under capital mobility. To achieve economic growth and low inflation, government leaders require two independent policy instruments: fiscal policy and monetary policy. States can either direct fiscal policy towards economic growth and monetary policy towards inflation control, producing a loose fiscal/tight monetary policy mix. Or they can direct fiscal policy towards inflation control and monetary policy towards economic growth, yielding a tight fiscal/loose monetary policy mix.; Monetary autonomy means holding an interest rate different from the world interest rate. Since the world interest rate has been nominally lower than most national interest rates, a policy mix that raises (lowers) interest rates will likely increase (decrease) monetary autonomy. Consequently, governments with a loose fiscal/tight monetary policy mix have effectively chosen greater monetary autonomy at the cost of exchange rate stability. Conversely, governments using a tight fiscal/loose monetary policy mix have opted for exchange rate stability with the associated costs of policy convergence.; I show next how domestic political institutions function as determinants of a state's fiscal/monetary policy mix and exchange rate variability in the post-Bretton Woods era. Leftist-led governments and multi-party governments in proportional representation electoral systems tend to choose policy autonomy with greater exchange rate variability. Conversely, rightist-led governments and single-party governments in majoritarian electoral systems opt for policy convergence to achieve exchange rate stability. These partisan and electoral factors function relatively unconstrained by other domestic institutions such as independent central banks and fixed exchange rate commitments. Likewise, the relative size of societal interest groups with differing preferences regarding the exchange rate stability/monetary autonomy tradeoff fails to explain the national government's policy choice.