Geopolitical Alignment and Exchange Rates

Abstract

ABSTRACT This paper examines how bilateral geopolitical alignment affects exchange‐rate movements across countries. Using a large country‐pair‐year panel based on Fan et al. (2025) and the World Development Indicators, we construct time‐varying bilateral measures of geopolitical alignment, exchange rates, and macroeconomic conditions for the period 1960–2025. The baseline results show that a one‐unit increase in geopolitical alignment is associated with 1.42–1.88 percentage points less relative currency depreciation. The decomposition results suggest that this effect mainly reflects a shift toward currency appreciation rather than a general reduction in the size of exchange‐rate fluctuations. The effects also vary significantly across regions, income groups, and World Bank lending categories. However, we find no systematic difference between high‐income and non‐high‐income economies.