Capitalism, Not Globalism by Clark William Roberts;

Author:Clark, William Roberts;
Language: eng
Format: epub
Publisher: University of Michigan Press

Conclusions

Our game-theoretic model makes fairly weak assumptions about the preferences of monetary and fiscal agents, but very strong assumptions about the institutional constraints under which they operate. The strong assumptions about the Mundell-Fleming conditions are made in part to make the analysis tractable, but they have the added benefit of stacking the deck in favor of falsification: if the predictions based on such a stark model withstand provisional tests, there are good reasons to believe that further refinement will be fruitful. Indeed, the empirical results support the insights of the model we have developed. Preelectoral monetary expansions are likely in states with mobile capital, a flexible exchange rate, and a dependent central bank, and they are absent otherwise; and preelectoral fiscal expansions are likely under mobile capital and fixed exchange rates.

These results have several interesting implications for the relationship between institutions and the international environment. In the presence of mobile capital, the exchange rate regime constrains the ability of policymakers to use one of the two macroeconomic instruments before elections. As states change their exchange rate regime, one should also expect a change in incumbents’ behavior before an election. If an open-capital state fixes its currency to the dollar, for example, one would expect a shift from monetary to fiscal policy instruments. One could argue that such a shift is already under way in Britain. Under Stage III of EMU, which began January 1, 1999, the European Union members anticipate the eventual creation of an Exchange Rate Mechanism II for countries that do not join the common currency. The expectation is that the band around the euro for these currencies will progressively narrow so that these countries will also experience more or less fixed exchange rates. Preelectoral monetary expansions will become less effective than fiscal expansions.

This change also has an important effect on the selection of institutions by governments. With respect to the trade-offs involved in enhancing central bank independence, a government may consider what it gives up in terms of survival in the next election if it relinquishes monetary policy autonomy in exchange for greater general price stability with a more independent central bank. A government in a flexible exchange rate economy will lose its ability to influence outcomes with macroeconomic policy before an election if it makes the bank more independent. If the government moves the country to a fixed exchange rate regime, however, it can gain some price stability while maintaining the ability to manipulate the economy before an election. Our results suggest, for example, that British Chancellor of the Exchequer Gordon Brown would have given up little in terms of the maneuverability of his government before the next election by granting the Bank of England greater independence in May 1997. The government would be able to initiate a fiscal expansion before the next election so long as Britain has joined the Exchange Rate Mechanism II by then.

These results also suggest why previous empirical results for fiscal cycles have been so ambiguous. Few studies consider the effects of different exchange rate regimes on the likelihood of fiscal cycles.

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