Exchange Rate Stability and Political Accountability in the European Monetary System. University of Illinois EUC Working Paper, Vol. 1, No. 1

Bernhard, William T. (2002) Exchange Rate Stability and Political Accountability in the European Monetary System. University of Illinois EUC Working Paper, Vol. 1, No. 1.

Abstract

The European Monetary System (EMS) created a policy standard—exchange rate stability—which domestic constituents could use to evaluate their government’s policy choices. Domestic social coalitions in favor of macroeconomic discipline could punish governments that violated this standard. I test the argument that devaluations within the EMS negatively affect the devaluing government’s approval ratings by using the London School/Hendry approach to model the approval ratings of the French prime minister and president from 1981–1992. The results indicate that devaluations did hurt the government’s approval ratings. I contend that the domestic political cost for violating the focal point of exchange rate stability provided member governments with an additional incentive to pursue disciplined economic policies throughout the 1980s. The incentive to avoid currency devaluations also helped to shape the response to the twin shocks of German monetary unification and the Maastricht Treaty. Since realignment would have damaged their domestic popularity, member governments were unwilling to adjust their parities, leading to the collapse of the EMS.