Elections, Fiscal Policy and Growth: Revisiting the Mechanism (original) (raw)
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Recent attempts to incorporate optimal fiscal policy into New Keynesian models subject to nominal inertia, have tended to assume that policy makers are benevolent and have access to a commitment technology. A separate literature, on the New Political Economy, has focused on real economies where there is strategic use of policy instruments in a world of political conflict. In this paper we combine these literatures and assume that policy is set in a New Keynesian economy by one of two policy makers facing electoral uncertainty (in terms of infrequent elections and an endogenous voting mechanism). The policy makers generally share the social welfare function, but differ in their preferences over fiscal expenditure (in its size and/or composition). Given the environment, policy shall be realistically constrained to be time-consistent. In a sticky-price economy, such heterogeneity gives rise to the possibility of one policy maker utilising (nominal) debt strategically to tie the hands of the other party, and influence the outcome of any future elections. This can give rise to a deficit bias, implying a sub-optimally high level of steady-state debt, and can also imply a suboptimal response to shocks. The steady-state distortions and inflation bias this generates, combined with the volatility induced by the electoral cycle in a stickyprice environment, can significantly raise the costs of having a less than fully benevolent policy maker. JEL Classification Codes: E62, E63
Electoral Uncertainty, Economic Policy and Growth
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It is widely believed that political factors (elections, partisan motives, and bureaucracy) are crucial in determining economic policies and in turn economic outcomes. 1 The early literature based on rational expectations focused on the link betweenelections andfiscal policy. For instance, RogoffandSibert (1988) showed how the incumbent political party manipulates policy instruments in an attempt to increase its re-election probability.
Electoral uncertainty and the deficit bias in a New Keynesian Economy
2008
Recent attempts to incorporate optimal fiscal policy into New Keynesian models subject to nominal inertia, have tended to assume that policy makers are benevolent and have access to a commitment technology. A separate literature, on the New Political Economy, has focused on real economies where there is strategic use of policy instruments in a world of political conflict. In this paper we combine these literatures and assume that policy is set in a New Keynesian economy by one of two policy makers facing electoral uncertainty (in terms of infrequent elections and an endogenous voting mechanism). The policy makers generally share the social welfare function, but differ in their preferences over fiscal expenditure (in its size and/or composition). Given the environment, policy shall be realistically constrained to be time-consistent. In a sticky-price economy, such heterogeneity gives rise to the possibility of one policy maker utilising (nominal) debt strategically to tie the hands of the other party, and influence the outcome of any future elections. This can give rise to a deficit bias, implying a sub-optimally high level of steady-state debt, and can also imply a sub-optimal response to shocks. The steady-state distortions and inflation bias this generates, combined with the volatility induced by the electoral cycle in a sticky-price environment, can significantly raise the costs of having a less than fully benevolent policy maker.
Elections, Fiscal Policy and Fiscal Illusion
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This paper tests the joint hypotheses that policymakers engage in fiscal policy opportunism and that voters respond by rewarding that opportunism with higher vote margins. Furthermore, it investigates the impact of fiscal illusion on the previous two dimensions. Empirical results, obtained with a sample of 68 countries from 1960 to 2006, reveal that opportunistic measures of expenditures and revenues generate larger winning margins for the incumbent and that the opportunistic manipulation of fiscal policy instruments is larger when the current government is less likely to be re-elected. Furthermore, fiscal illusion contributes to the entrenchment of incumbent policymakers in office and promotes opportunistic behaviour.