Exchange rates are an expedient corrective for an imprudent policy approach

The recent years have seen changes in the political landscape. Nationalistic and right-wing populist groupings have gained hugely in importance. This holds true for Germany, and Europe in general, just as it does for countries such as the USA or the Philippines. Or for Brazil, where a man – Jair Bolsonaro – was elected president with a clear majority last weekend who reveres the former military dictatorship and regards torture as a “legitimate practice” in the context of police work.

It is true that foreign-exchange markets are known for their ability to adjust to the framework conditions prevailing at any particular point in time. All the same, this should not blind one to the fact that a higher political profile for nationalistic factions may possibly result in significant downside pressure on a country’s currency. Four channels can be identified through which such depreciation takes place: 1.) the triumphant advance of representatives from such groupings leads to greater uncertainty about the political future of a given country; 2.) a structural break (Brexit) causes the economic outlook to deteriorate after a short time-lag; 3.) the need to finance expensive populistic pre-election promises (Italy) means that a question mark hangs over the future market access of the state in question; 4.) the independence of the national central bank is in jeopardy (Turkey).

Provided that none of these four channels is affected, however, foreign-exchange markets are quite willing to take the growing role of right-wing populist parties in a currency zone very much in their stride. The implication is that reams of blustering rhetoric, intolerance, brazen public behaviour – or even erosion of the separation of powers and the curtailing of the freedom of speech and of the freedom of the press – are not sufficient to put pressure on a currency in a lasting way. Indeed, a country’s exchange rate may even benefit provided that the heads of state concerned – as in the case of Trump or Bolsonaro – are seeking to steer a pro-business political course.

The tolerance of forex investors will probably reach its limits especially when justified doubts about the independence of monetary policy arise. In this connection, it is questionable to what extent right-wing populist movements would be prepared, in the long run, to accept an authoritative independent body taking its bearings by such objectives as sustainable growth and price stability as their peer. This principle applies above all in cases where the monetary-policy stance runs counter to the goals of those holding political responsibility.

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