44 WORLD POLITICS as part of a stabilization strategy.Adopting a nominal anchor as part of a stabilization effort generally leads to an appreciation of the real ex- change rate and a falling real interest rate,thus feeding a consumption boom of imports,a burst of investment,and a gradual deterioration of the current account.Under an open capital account,inflows of capital can finance the trade deficit in the short term.However,because the burgeoning current account deficit is unsustainable in the medium term,it often induces inconsistent fiscal policies,which in turn affect the credibility of the peg.At this point the sustainability of the regime itself comes into question:runs on the currency become widespread, usually with important losses in foreign-exchange reserves(as the gov- ernment tries to defend the parity)and,inevitably,a departure from the fixed exchange rate arrangement with a subsequent devaluation. This rendition conforms to the stylized facts of a balance-of-payment crisis as outlined in Krugman's seminal article.3 Moreover,it is also con- sistent with the main attributes of many exchange-rate and financial crises seen in much of the developing world:the Southern Cone of Latin America in the 1980s,Mexico,Asia,Russia,and Brazil in the 1990s,Turkey in 2001,and Argentina's explosive termination of the currency board in 2002(accompanied by the default on its external debt),to name a few prominent examples.If these boom/bust cycles appear with some frequency as a result of exchange rate-based stabi- lizations,the appeal of such programs-and,more generally,the nom- inal anchor approach to the exchange rate-appears puzzling.Why do governments implement policies that generate a short-term boom but are prone to collapse later in a sequence of devaluation and inflation that results in a severe balance-of-payment crisis and potentially poor economic performance? The literature on the political economy of exchange rates has left this question unanswered.The various contributions,including Krugman's, have showed how exchange rate crises unfold but not why govern- ments repeatedly choose those policies,exposing themselves to known risks.We embark on this discussion with a political economy explana- tion based on the notion of a self-interested government for which short-term stabilization is attractive in the face of incentives posed by the electoral cycle.If the election coincides with the boom phase, incumbent governments increase their likelihood of winning re- election-as the bust phase will develop,if at all,only after the contest. 3Paul Krugman,"A Model of Balance-of-Payments Crises,"Journal of Money,Credit,and Banking 11(August1979).as part of a stabilization strategy. Adopting a nominal anchor as part of a stabilization effort generally leads to an appreciation of the real ex￾change rate and a falling real interest rate, thus feeding a consumption boom of imports, a burst of investment, and a gradual deterioration of the current account. Under an open capital account, inflows of capital can finance the trade deficit in the short term. However, because the burgeoning current account deficit is unsustainable in the medium term, it often induces inconsistent fiscal policies, which in turn affect the credibility of the peg. At this point the sustainability of the regime itself comes into question: runs on the currency become widespread, usually with important losses in foreign-exchange reserves (as the gov￾ernment tries to defend the parity) and, inevitably, a departure from the fixed exchange rate arrangement with a subsequent devaluation. This rendition conforms to the stylized facts of a balance-of-payment crisis as outlined in Krugman’s seminal article.3 Moreover, it is also con￾sistent with the main attributes of many exchange-rate and financial crises seen in much of the developing world: the Southern Cone of Latin America in the 1980s, Mexico, Asia, Russia, and Brazil in the 1990s, Turkey in 2001, and Argentina’s explosive termination of the currency board in 2002 (accompanied by the default on its external debt), to name a few prominent examples. If these boom/bust cycles appear with some frequency as a result of exchange rate–based stabi￾lizations, the appeal of such programs—and, more generally, the nom￾inal anchor approach to the exchange rate—appears puzzling. Why do governments implement policies that generate a short-term boom but are prone to collapse later in a sequence of devaluation and inflation that results in a severe balance-of-payment crisis and potentially poor economic performance? The literature on the political economy of exchange rates has left this question unanswered. The various contributions, including Krugman’s, have showed how exchange rate crises unfold but not why govern￾ments repeatedly choose those policies, exposing themselves to known risks. We embark on this discussion with a political economy explana￾tion based on the notion of a self-interested government for which short-term stabilization is attractive in the face of incentives posed by the electoral cycle. If the election coincides with the boom phase, incumbent governments increase their likelihood of winning re￾election—as the bust phase will develop, if at all, only after the contest. 44 WORLD POLITICS 3Paul Krugman, “A Model of Balance-of-Payments Crises,” Journal of Money, Credit, and Banking 11 (August 1979). v56.1.043.schamis 3/2/04 4:29 PM Page 44