The Disadvantage of Tying Their Hands: On the Political Economy of Policy Commitments

In order to increase their electoral chances, incumbents may forego policy measures that improve the relative standing of their opponents in the eyes of voters. This paper illustrates the point by focusing on the choice between fixed and floating exchange rates. An inflation-averse government may refrain from choosing fixed exchange rates in order to capitalise on the `inflationary' reputation of its opponent. This incentive is contrasted with the opposite incentive to `tie the hands' of its opponent should the latter win the election. For a more inflationary government, electoral considerations reinforce the incentive to `tie its own hands' with fixed exchange rates.