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The Conditional Effect of Interest Groups on Undervalued Exchange Rates
David SteinbergUniversity of Oregon
The Puzzle
Undervalued Exchange Rates are Beneficial
– Increases economic growth (Dollar 1991; Rodrik 2008)
– Reduces unemployment (Frenkel & Ros 2006)
– Prevents financial crises (Reinhart & Rogoff 2009)
Exchange Rate Overvaluation (Median 2006)
All Developing Countries 3.4%Middle East & North Africa 18.1%Sub-Saharan Africa 7.9%
Latin America 7.9%Eastern Europe 25.9%
Asia -22.4%
…but Rare
Overview
• Question: Why do (only) some developing countries maintain “undervalued” exchange rates?– Undervaluation defined: Domestic goods cheap relative to
foreign goods
• Theory: Conditional interest group approach– Manufacturing sector only promotes undervaluation when
state controls bank sector
• Empirics: Two tests– TSCS: Determinants of undervalued exchange rates– Survey: Determinants of exchange rate preferences
Preferences
• Manufacturing Firms’ Preferences: Ambiguous– Benefit: External competitiveness – Cost: Cost imported inputs & foreign debt– Cost: Sterilized intervention interest rates
• Cost-reducing Compensations: Increase support for undervalued exchange rates– No compensations: Undervaluation increases both revenues &
expenses– Compensatory policies: Undervaluation increases revenues;
expenses do not increase
State-Owned Banks
• State-Owned Banks: Reduce business costs– Targeted credit (i.e. “industrial policy”)– Forced placement of sterilization bills
• Hypothesis 1: state-owned banks, industry support undervaluation
Conditional Effect of Interest Groups
• Hypothesis 2: Undervalued exchange rates are most likely in countries with large manufacturing sectors AND state-controlled financial systems
Analysis I: Determinants of Undervalued Exchange Rates
• Sample: Developing countries, 1975-2006
• Dependent Variable: RER Overvaluation (Rodrik)– Overvaluation = RERit - RERPREDICTit
• Independent Variables– Manufacturing: Manufacturing/GDP (WDI)– State-owned banks: 4-category ordinal var. (Abiad et al)– Interaction Term: Manufacturing State-Owned Banks
• Estimation: AR1, PCSE, Fixed Effects
Analysis II: Determinants of Exchange Rate Preferences
• Sample: Manufacturing firms in developing countries in 1999 (World Business Environment Survey)
• Dependent Var.: Exchange Rate Problem (Broz et al)
• Independent Variables– Overvaluation: Same as before (Rodrik)– State-owned banks: Continuous var. (Micco et al)– Interaction Term: Overvaluation State-Owned Banks
• Estimation: Ordered Probit, Robust SE
Conclusions• Exchange Rate Politics– Interest groups matter…but only under certain conditions– Undervalued exchange rates rare b/c tradable industries
do not always support undervaluation
• Implications for IPE:– Preferences are context-dependent– States (capacity) shapes preferences
• Implications for Policymakers– Various elements of the Washington Consensus
incompatible