Policy choices in tough times: The case of democratization and currency defense

Abstract

Do policymakers under financial and political distress make undesirable policy choices? This paper attempts to answer this question by studying the relationship between democratization and currency devaluation under speculative pressures. The central argument is that young democracies exhibit relatively high probabilities of succumbing to speculative attacks, as the political cost of economic adjustment needed for defense is relatively high for these nascent regimes. The paper further contends that this relationship is stronger when the regime can mobilize fewer resources to defend their currencies. To test these arguments, this paper uses monthly data for 117 countries from 1975 to 2008. The results from statistical analysis provide corroborative evidence for these arguments.