Political Opportunism and Countercyclical Fiscal Policy in Election‐year Recessions

Abstract

Political budget cycles (PBCs) have been well documented in the literature, albeit not for all circumstances. Similarly, there is clear evidence on the positive effect of economic growth on electoral success. However, no work has been done on the impact of economic growth on the magnitude of PBCs. The theoretical model argues that a government has an incentive to increase fiscal manipulations when a recession is expected to hit and curtail reelection chances; this amounts to countercyclical policy for opportunistic rather than Keynesian motives. Very robust evidence for this behavior is found in Portuguese municipalities; in election years, budget deficits go up even more and significantly so, when a recession is expected. (JEL D72, E62, H62)

Elections, recession expectations and excessive debt: an unholy trinity

“…The forecasted regional real GDP growth rate, RegGDPf i,t is interacted with ElY i,t , so that we can check whether the effects of expectations for economic growth in election years are different from those in the other years of the electoral cycle. 14 Based on the theoretical model and on previous empirical evidence of PBCs in Portuguese municipalities (e.g., Bohn and Veiga 2017;Aidt et al 2011;Veiga and Veiga 2007), we expect a positive 1 , consistent with larger budget deficits in election years. Additionally, a negative 3 is expected, given the model's prediction that expected negative or unusually low growth rates lead to larger deficits, while positive growth rates lead to surpluses.…”

“…Veiga et al (2017) confront several of those conditioning factors and find that media freedom is key in reducing the incidence of PBCs. Bohn and Veiga (2017) move the focus to economic conditions and present evidence showing that recessionary expectations reinforce the political budget cycle.…”

“…The model combines elements from Lohmann (1998), Shi and Svensson (2006) and Bohn and Veiga (2017). It captures an economy with n voters and two opportunistic candidates, an incumbent and a challenger, who compete for holding office every alternate period.…”

“…In Rogoff's world, politicians observe their own competence skills before voters do; hence, we obtain a signalling model. In the Lohmann (1998) and Shi and Svensson (2006) world, some part of the electorate is uninformed or has some other handicap; in Bohn and Veiga (2017), it is inertial growth perceptions. It is important, however, that politicians cannot observe their own competence shocks.…”

“…Analogous arguments could be made for expected booms. The factors determining the magnitude of the countercyclical policy effect already were studied by Bohn and Veiga (2017).…”