Elections and the timing of devaluations

Abstract

This paper presents a rational political budget cycle model where devaluation acts as a tax on consumption due to a cash-in-advance constraint. Competent governments can signal their competency by reducing the rate of devaluation prior to elections. When voters also ignore the degree to which governments are opportunistic, i.e. the extent to which they are willing to distort the economy for electoral gain, an incompetent, opportunistic incumbent can reduce the rate of devaluation in the run-up to an election. The main theoretical implication in either setup, that the rate of devaluation is significantly higher in the months following an election, is consistent with evidence drawn from 26 countries in Latin America.