Domestic Interests and Exchange Rate Policy

Currency Politics is perhaps the most important political economy book yet written about the most important price in every national economy—the exchange rate. Frieden draws on more than a quarter century of his own careful research to show how competition between economic interest groups influences government choices about exchange rate policy in theory and to demonstrate the extent to which these theoretical expectations help us to understand actual exchange rate policy choices across a wide range of places and periods. The book is essential reading. Frieden offers the reader one chapter of theory and five chapters of empirical material, bookended by introductory preliminaries and concluding thoughts. The theoretical chapter (chapter 1) articulates a refined version of Frieden’s sectoral model of exchange rate policy preferences (put forth initially in 1991). This model predicts two dimensions of firms’ exchange rate policy preferences—the preference over the degree of exchange rate stability and the preference over the level of the exchange rate—based on the sector in which they are based. To simplify greatly, Frieden argues that exchange rates have distributional consequences. Some firms, especially those heavily engaged in international trade, benefit from a fixed and undervalued currency. Other firms, such as those in sheltered industries that sell exclusively to domestic consumers, benefit from a strong and flexible currency. Exchange rate policy thus reflects the relative political influence of these various economic groups. If export-oriented firms are most influential, for instance, the currency is likely to be fixed at an undervalued rate. Though students of exchange rates will find much of the theoretical argument familiar, as it builds on work that Frieden published more than twenty years ago, the book does offer a few theoretical refinements to this core model. Most significant among these is the incorporation of exchange rate pass-through. Exchange rate pass-through is the extent to which domestic prices rise and fall in response to exchange rate movements. Prices of some products, such as agricultural commodities, are very sensitive to exchange rate movements, while others, such as automobiles, are not. As a consequence, two export-oriented firms with different degrees of exchange rate pass-through will have different exchange rate policy preferences even though they are in the same sector. The incorporation of exchange rate pass-through thus adds substantial intrasector variation to the basic model

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