Abstract
This paper investigates political business cycles in small open economies operating under a regime of flexible exchange rates. In open economies the monetary authorities are able to manipulate the money supply to influence the inflation rate and real income via the exchange rate. If the monetary authorities attempt to maximize the government’s probability of reelection, the optimum monetary policy generates a cyclical pattern in the exchange rate. A time series analysis of the exchange rates of eight countries shows that the empirical evidence is not grossly at variance with the political business cycle theory.
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