Ambiguity and Partisan Business Cycles

Anna Maffioletti and Michele Santoni

FinanzArchiv: Public Finance Analysis, 2002, vol. 59, issue 3, 387-406

Abstract: We introduce ambiguity (Knightian uncertainty) into a stripped-down version of Alesina's (1987) partisan model of the business cycle. We show that, if the private sector's subjective expectations of future events are ambiguous, there is the possibility of a political business cycle, even when the parties running for the election have similar preferences for inflation and unemployment. In particular, if inflation is perceived as a loss, then the larger the fraction of the population that is ambiguity-prone (-averse), the larger is the postelection boom (slump), with unemployment then returning back to its natural level. We also show that, for given parties preferences, ambiguity proneness (aversion) implies smaller (larger) fluctuations in the unemployment around its natural level when the right-wing party wins the elections. (Keywords: Ambiguity, Ellsberg's paradox, Partisan theory of the business cycle, Unemployment)

JEL-codes: D81 E32 E42 (search for similar items in EconPapers)
Date: 2002
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