Democracy and Markets: The Case of Exchange Rates

Abstract

Economic Studies Division of theOesterreichische Nationalbank study the impact of political information on exchange rates.In this interdisciplinary approach the authors combine theoretical results from the field of political science with those of economics to develop stylized facts about the impact of democratic institutions on economic equilibration.The authors develop several competing propositions about how political equilibration affects currency markets.Then these propositions are tested by means of a Markov switching model with time-varying transition probabilities which are governed by political information.The political variables used are government approval, the probability of government dissolution, the probability of government reelection and a measure of electoral uncertainty based on the concept of entropy.In general, the results show that information about electoral outcomes and opinion polls about chief executive performance do affect exchange rates.Also, there is some evidence that political effects are weaker in countries with proportional representation electoral systems than in countries with majority-plurality systems.

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