Electoral uncertainty and the deficit bias in a New Keynesian Economy

Campbell Leith and Simon Wren-Lewis

Working Papers from Business School - Economics, University of Glasgow

Abstract: 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 thankfully benevolent policy maker.

Keywords: New Keynesian Model; Government Debt; Monetary Policy; Fiscal Policy, Electoral Uncertainty, Time Consistency. (search for similar items in EconPapers)
JEL-codes: E62 E63 (search for similar items in EconPapers)
Date: 2008-05, Revised 2009-02
New Economics Papers: this item is included in nep-cba, nep-cdm, nep-mac and nep-pol
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Electoral Uncertainty and the Deficit Bias in a New Keynesian Economy (2009)
Working Paper: Electoral Uncertainty and the Deficit Bias in a New Keynesian Economy (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2009_11

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