Is rationalist institutionalism correct? : markets and domestic structures in the 1992/93 ERM crisis
This thesis investigates the influence of domestic institutional structures on international financial market sentiment during financial crises. It asks whether rationalist institutionalism is correct by suggesting that financial market participants make optimising rational choices about domestic institutions when assessing whether exchange rate commitments by national policymakers are consistent with domestic policy constraints. To clarify the issue I have undertaken an empirical study of market sentiment from a procedural angle. I use focused structured comparison as a means of undertaking an investigation of the process of market decision-making during a single historical episode in which the credibility of currency commitments was at stake, the 1992/93 ERM crisis. This approach allowed for a rigorous detailed longitudinal reconstruction of how domestic institutional variables, which have been identified by rationalist institutionalism as critical for monetary policy outcomes (financial structure, wage bargaining structure, political structure), influenced market sentiment towards pound sterling, the French franc and the D-mark. I conclude that, firstly, market participants took account of domestic institutional structures in a broadly rational fashion. But given that, in the practice of financial market trading, information is incomplete and the cognitive capacities of market analysts are limited, market rationality is bounded and not optimising. Market participants "satisfice": they economise on their decision-making by stopping the process of assessment at a practically acceptable, rather than an optimal solution. This leads to inefficient market outcomes manifested in unstable expectations about institutions and lack of robustness in institutional analysis. Secondly, market sentiment is characterised by uncertainty about the structural underpinnings of political exchange rate commitments, allowing considerable room for national policy-making autonomy through strategic interaction between national policymakers and international financial markets. Thirdly, the practical nature of decision-making by financial market participants has not been recognised by rationalist institutionalism, explaining its theoretical ambiguities regarding the influence of domestic institutions on market sentiment.