Polarized business cycles

Abstract

We are motivated by four stylized facts computed for emerging and developed economies: (i) business cycle movements are wider in emerging countries; (ii) economies in emerging countries experience greater economic policy uncertainty; (iii) emerging economies are more polarized and less politically stable; and (iv) economic policy uncertainty is positively related to political polarization. We show that a standard real business cycle (RBC) model augmented to incorporate political polarization, a 'polarized business cycle' (PBC) model, is consistent with these facts. Our main hypothesis is that fluctuations in economic variables are not only caused by innovations to productivity, as traditionally assumed in macroeconomic models, but also by shifts in political ideology. Switches between left-wing and right-wing governments generate uncertainty about the returns to private investment, and this affects real economic outcomes. Since emerging economies are more polarized than developed ones, the effects of political turnover are more pronounced. This translates into higher economic policy uncertainty and amplifies business cycles. We derive our results analytically by fully characterizing the long-run distribution of economic and fiscal variables. We then analyze the effect of a permanent increase in polarization on PBCs.

The Political Color of Fiscal Responsibility

“…SSZ consider an integrated world economy but do not study a stochastic environment. Bachmann and Bai (2013) and Azzimonti and Talbert (2014) analyze dynamic fiscal policy with stochastic preferences for public goods and productivity shocks, but limit the analysis to balanced-budget policies. Battaglini (2014) presents a theory of electoral competition where voters with stochastic preferences for parties determine public debt accumulation and fiscal policy, but focuses on the efficiency comparison of different electoral rules and not on the political color of governments.…”

Budget flexibility, government spending, and welfare

“…For example, on the theoretical side, Alesina, Baqir, and Easterly (1999) show that polarization decreases the provision of public goods if allocation of tax revenue is decided after the tax is collected, Azzimonti (2011) shows that polarization decreases investment and increases government spending, and Azzimonti and Talbert (2014) show that polarization increases macroeconomic fluctuations. On the empirical side, Lindqvist and Östling (2010) state that polarization is associated with lower government spending in strong democracies, and Alt and Lassen (2006) state that, among advanced economies, electoral cycles are larger in more polarized countries.…”

The dynamics of public investment under persistent electoral advantage

“…The result follows from assuming that both agents have the same trade-off between private and public consumption (i.e., u and v are equal for all agents). 6 Departures from these conditions from zero represent gaps or wedges relative to the first best. For future reference, we will define the public goods' provision wedge with Δ g , the labor wedge with Δ n , and the investment wedge with Δ k , respectively.…”

“…5 If the planner only cares about the well-being of, say, agent A, it will set g B t = 0 ∀t and g A t so as to equate the marginal rate of substitution between private and public goods to the marginal cost of providing the goods x g (g). 6 It is important to note that the planner is constrained to offer all households the same consumption allocation (that is, c A = c B ). This condition is imposed in order to capture the constraint faced by the government in the political equilibrium (where parties cannot tax agents at different rates).…”