Exchange Rate Politics

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"Exchange Rate Politics" is an essay written by Jeffry A. Frieden. In it, Frieden argues that: (1) greater economic openness leads to greater politicization of currency policy and increased debate over exchange rates; and (2) debate over exchange rates gives rise to predictable patterns of social and political cleavages.

1) Frieden contends that financially open economies are likely to produce a higher level of politicization and debate over exchange rates than that produced by financially closed economies because integration of goods and capital markets have a more immediate and significant affect on the interests of economic and political actors. In closed economies, monetary policy impacts the nominal price level but not relative prices between goods and services. Relations between different interest groups are changed very little, and so their interests regarding monetary policy are also rarely changed or invigorated. In open economies, on the other hand, monetary policy, by adjusting the exchange rate, changes the prices of imports and exports and shifts the relative prices of goods and services. Interests of various groups (exporters, importers, producers, banks, etc.) are affected and thereby naturally lead them to intensify their activity in regard to exchange rate politics.

2) Frieden also asserts that "different economic agents can be expected to have different views of the trade-off between exchange rate stability and national ability to affect domestic monetary conditions" (Frieden, 259). Those whose business is domestic will prefer that the country maintain national policy independence, which requires a flexible exchange rate. Those immersed in international trade and investment will prefer a fixed exchange rate, because they care more about price stability than domestic conditions. In addition, different goroups will advocate for different levels of the exchange rate. Producers of tradable goods will favor a weaker (depreciated) currency and exchange rate, which would make their goods cheaper and in greater demand in relation to foreign goods. Producers of non-tradable goods and services, as well as foreign investors, favor a stronger (appreciated) currency and exchange rate because it sustains high prices of the producer's products relative to tradable goods in the domestic market and it allows the inverstors to purchase foreign assets more cheaply.

Frieden, Jeffry A. "Exchange Rate Politics." International Political Economy: Perspectives on Global Power and Wealth. Ed. Jeffry A. Frieden and David A. Lake. Boston, MA: Bedford/St. Martin's, 2000.