Central banks’ priorities and the left/right partisanship of exchange rates

Abstract

This study argues that when central banks subordinate all policy goals to achieving price stability greater central bank independence encourages left-wing governments to seek greater exchange rate stability. Such central bank policy priorities make the Left's preferred distributive policies more dependent on the effectiveness of fiscal policy, which under high capital mobility increases with exchange rate stability. In contrast, right-wing governments put greater emphasis on market adjustments and price stability. Hypotheses are tested by estimating the sensitivity of exchange rate variation to partisanship, central bank independence, and the salience of price stability, using a Prais–Winsten estimator and Instrumented Variables, run on pooled cross-section time-series data from 22 OECD countries during 1990–2004.