Is the exchange rate politically manipulated around elections? The evidence from Uruguay

In a small open economy, the exchange rate is a key variable from the perspective of the political economy of macro policy. It is, indeed, one of the most powerful instruments that governments can use to achieve their goals. Recent theories of political macroeconomics stress that maximization of social welfare may be just one, and perhaps not the most relevant, of such goals. Others include politicians’ own permanence in power and serving the interests of specific constituencies. This paper seeks to determine the pertinence for the Uruguayan economy of the recent literature on the political economy of exchange rate management. The predictions of various theoretical models are summarized, along with the stylized facts identified in a series of recent empirical studies. After a brief discussion on the advantages of alternative specifications to test for political cycles in the exchange rate, the theoretical predictions and stylized facts are confronted with the evidence for Uruguay since 1920. The analysis shows empirical regularities consistent with political manipulation of the exchange rate around elections.