The Politics of Surprise Devaluations: Modelling Motives for Giving Up a Peg

Abstract

Planned ‘‘surprise’’ devaluations are often spurred by non-economic circumstances: a rentseeking government; political instability; or the opportunity to put the blame on a predecessor government. In this paper, these aspects are incorporated in the monetary and fiscal policy framework first suggested by Alesina and Tabellini (1987). It is shown that reneging on a fixed exchange rate promise unambiguously produces short term benefits, but long run losses. This leads to a non-straightforward trade-off between greediness (propensity for expropriation) and political stability (which implies a low time preference). The findings are empirically relevant and theoretically robust to extensions.