A political economy analysis of exchange rate regimes and currency crises: A large N empirical study

The recent rash of international currency crises has generated considerable interest in the role that exchange rate regimes have played in contributing to these crises. Today almost all international monetary economists accept the "unstable middle" hypothesis in the form that states that Bretton Woods type narrow-band adjustable pegs will be highly crisis prone in the face of substantial capital mobility. There is substantial disagreement, however, on how far toward the extremes of fixed or flexible exchange rates countries need to go in order to substantially reduce the likelihood of currency crises. This dissertation addresses these questions and empirically investigates the stability of alternative exchange rate regimes from both political institutional aspects as well as standard economic considerations.; Using cross-section time series data for 90 countries over the period of 1990 to 2003, this dissertation begins with examining the correlations among exchange rate regime and currency crises. The main findings are that the dead center of the adjustable peg is the most crisis-prone broad type of exchange rate regime, but that countries need not go all the way to permanently fixed rates or freely floating rates to substantially reduce the risks of currency crises. In addition, the interaction between political institutional factors and exchange rate regimes on the likelihood of currency crises is examined since the cross-national differentiation in political structure directly influences a government's ability to take timely actions to head off crises. The empirical results show that the vulnerability to currency crises appears to be higher for countries with a high degree of government instability and coalition government, regardless of which type of exchange rate regime it adopts. In particular, these weak political institutions combined with an adjustable pegged exchange rate system represent the highest probability of currency crises, as compared with other types of exchange rate regimes. These findings are consistent with the "unstable middle" hypothesis, but not in line with the "two corners" hypothesis.