How Constraining is Capital Mobility? The Partisan Hypothesis in an Open Economy

Abstract

A growing literature argues that international financial integration has eliminated the possibility for distinct partisan macroeconomic strategies. I test this hypothesis by reformulating the partisan hypothesis in an open-economy context and conducting pooled timeseries analysis of budget balances, real interest rates, and capital controls for fourteen OECD countries between 1970 and 1994. The analysis provides little evidence that financial integration has eliminated distinct partisan macroeconomic policies. Under fixed exchange rates leftist governments run larger deficits than rightist governments and use capital controls to reduce interest rate premia. Under floating exchange rates leftist governments pursue looser monetary policies than rightist governments. While partisan distinctions do weaken in the 1990s in countries with fixed exchange rates, this is attributed to the recession of the early 1990s and to important institutional changes in the European Union. International financial integration, therefore, does not prevent governments from pursuing distinct partisan macroeconomic policies.