FOREIGN EXCHANGE INTERVENTION AND THE POLITICAL BUSINESS CYCLE: A PANEL DATA ANALYSIS

By combining expansionary open market operations with sales of foreign exchange, the central bank can expand the monetary base without depreciating the exchange rate. Thus, if there is a monetary political business cycle, sales of foreign exchange are especially likely before elections. Our panel data analysis for up to 158 countries in 1975-2001 supports this hypothesis. Foreign exchange reserves relative to trend GDP depend negatively on the pre-election index regardless of the exchange rate system. The relationship is significant and robust irrespective of the type of electoral variable, the choice of control variables and the estimation technique.