The political economy of a managed float: Special interests, monetary authorities, and regime choice

With heterogeneous productivity and sticky prices in the short run, exchange rate changes can generate real effects on agents in the economy; the result is that the currency regime becomes a policy variable amenable to political competition. This paper discusses how special interests and government policymakers interact in the decisionmaking processes concerning the optimal level of the exchange rate, and how these interactions may lead to a disconnect between the exchange rate and economic fundamentals. Three extensions to the benchmark model consider the possibility of a semi-independent monetary authority, the existence of a legislature, and electoral pressures.