Data Business Analysis

Read Complete Research Material

Data Business Analysis

Data Business Analysis


There is abundant evidence that many central banks tend to pursue significantly more expansionary monetary policies before elections than in normal times. This is true even for independent central banks especially if most members of the central bank council have been appointed by the incumbent government or the ruling parties. However, there are also cases in which we would not expect a monetary political business cycle for example, if there is no doubt about the re-election of the government, if the election has to be called at short notice or if the central bank is independent and the government lacks a partisan majority in the central bank council. Thus, the evidence is likely to vary across countries and over time.

The hypothesis

What has not been analyzed so far is the way in which monetary acceleration before elections is brought about. This is surprising because the economic and electoral effects of an accelerating monetary base growth may crucially depend on whether and to what extent the central bank expands the domestic or the foreign component of the monetary base. The main difference of effect relates to the exchange rate. If the exchange rate is fixed, the central bank is likely to prefer a monetary expansion without devaluation. However, even under a flexible exchange rate regime, the authorities will probably wish to minimize the exchange rate effects of the monetary acceleration because a depreciation of the currency would be a very visible sign of pre-electoral pump-priming and because it would instantaneously raise import prices and feed into the general price level.

A loss of foreign exchange reserves, it is true, may also be unpopular but it is less visible and less important to the general public than exchange rate depreciation and import price inflation. Whether it is also less important to the monetary authorities is an issue that can and ought to be tested. We use the asset market approach (the monetary and the portfolio balance approach) to recapitulate why sales of foreign exchange tend to reduce the depreciation associated with a given increase of the monetary base. Ideally, the central bank might also wish to increase the monetary base of the foreign reserve currency to which its own currency is pegged (Vaubel, 2001 204-244). In the monetary approach to the exchange rate, this would create room for raising domestic monetary base growth while maintaining the exchange rate parity. The domestic central bank can achieve this objective by first selling foreign exchange reserves held with the foreign central bank in exchange for its own central bank money, then sterilizing the reduction of its central bank money supply through open-market operations and finally raising its own rate of monetary expansion in line with the foreign monetary acceleration which its foreign exchange interventions have brought about.

Of course, the sequence of events may be the reverse. The central bank may start by increasing the domestic component of its monetary base through open-market operations, then prevent depreciation by selling foreign currency and finally sterilize ...
Related Ads