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A Theory of Political and Economic Cycles

Laurence Ales, Pricila Maziero and Pierre Yared

No 18354, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a theoretical framework in which political and economic cycles are jointly determined. These cycles are driven by three political economy frictions: policymakers are non-benevolent, they cannot commit to policies, and they have private information about the tightness of the government budget and rents. Our first main result is that, in the best sustainable equilibrium, distortions to production emerge and never disappear even in the long run. This result is driven by the interaction of limited commitment and private information on the side of the policymaker, since in the absence of either friction, there are no long run distortions to production. Our second result is that, if the variance of private information is sufficiently large, there is equilibrium turnover in the long run so that political cycles never disappear. Finally, our model produces a long run distribution of taxes, distortions, and turnover, where these all respond persistently to temporary economic shocks. We show that the model's predictions are consistent with the empirical evidence on the interaction of political and economic cycles in developing countries.

JEL-codes: D82 E62 H21 P16 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-cta, nep-dge and nep-pol
Note: EFG POL
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Published as Ales, Laurence & Maziero, Pricila & Yared, Pierre, 2014. "A theory of political and economic cycles," Journal of Economic Theory, Elsevier, vol. 153(C), pages 224-251.

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