Advertisement

Computational Economics

, Volume 53, Issue 1, pp 125–140 | Cite as

A Stochastic Model with Inflation, Growth and Technology for the Political Business Cycle

  • Gopal K. Basak
  • Mrinal K. Ghosh
  • Diganta MukherjeeEmail author
Article
  • 117 Downloads

Abstract

This paper analyzes an augmented political business cycle model taking into account the effect of employment creation decisions by the ruling party jointly on inflation and growth. The objective is to maximize voter support in the next election that depends on the rate of unemployment as well as that of growth and inflation. We allow for stochasticity in the New Keynesian Phillips Curve model for the relationship between inflation and unemployment as well as in a benchmark labour productivity function for analyzing the growth rate. We provide explicit solution paths of the affine Markov control problem that results from our formulation. We also provide numerical illustrations with plausible parametric configurations to generate more insight into our model. Our results are broadly in line with the conventional wisdom of Phillips curve, with inflation and unemployment being roughly negatively related. The growth rate is, as expected, negatively related to the unemployment. We observe that, in the sequel, it is the lowering of the rate of inflation that provides support for the ruling party. Thus, electoral pressures drive the government to engage in cost control rather than productive investment (e.g., boosting employment or output growth).

Keywords

Political business cycle New Keynesian Phillips Curve Inflation Growth Technology aversion Stochastic optimal control 

JEL Classification

C63 P16 

References

  1. Aisen, A., & Veiga, F. J. (2013). How does political instability affect economic growth? European Journal of Political Economy, 29, 151–167.CrossRefGoogle Scholar
  2. Basak, G. K., Ghosh, M. K., & Mukherjee, D. (2016). A mean-reverting stochastic model for the political business cycle. Stochastic Analysis and Applications, 34(1), 96–116.CrossRefGoogle Scholar
  3. Beck, N., & Katz, J. N. (2011). Modeling dynamics in time-series-cross-section political economy data. Annual Review of Political Science, 14, 331–352.CrossRefGoogle Scholar
  4. Blanchard, O., & Gali, J. (2007). Real wage rigidities and the new keynesian model. Journal of Money, Credit and Banking, 39, 35–65.CrossRefGoogle Scholar
  5. Castro, V., & Veiga, F. J. (2004). Political business cycles and inflation stabilization. Economics Letters, 83, 1–6.CrossRefGoogle Scholar
  6. Chiang, A. C. (1992). Elements of dynamic optimization. New York: McGraw Hill International Editions.Google Scholar
  7. Christiano, L., Eichenbaum, M., & Evans, C. (2005). Nominal rigidities and the dynamic effects of a shock to monetary policy. Journal of Political Economy, 113(1), 1–45.CrossRefGoogle Scholar
  8. Feng, Y. (2005). Democracy, governance, and economic performance: Theory and evidence. Cambridge: MIT Press.Google Scholar
  9. Fleming, W. H., & Soner, H. M. (2006). Controlled Markov processes and viscosity solutions (2nd ed.). New York: Springer.Google Scholar
  10. Fragoso, M. D., & Baczynski, J. (2005). On an infinite dimensional perturbed Riccati differential equation arising in stochastic control. Linear Algebra and Its Applications, 406, 165–176.CrossRefGoogle Scholar
  11. Fragoso, M. D., & Hemerly, E. M. (1991). Optimal control for continuous-time linear quadratic problems with infinite Markov jump parameters. International Journal of Systems Science, 22(12), 2553–2561.CrossRefGoogle Scholar
  12. Gali, J., & Gertler, M. (1999). Inflation dynamics: A structural econometric analysis. Journal of Monetary Economics, 44(2), 195–222.CrossRefGoogle Scholar
  13. Kiley, M. T. (2016). Policy paradoxes in the new Keynesian model. Review of Economic Dynamics, 21, 1–15.CrossRefGoogle Scholar
  14. Milani, F. (2010). Political business cycles in the new Keynesian model. Economic Inquiry, Western Economic Association International, 48(4), 896–915.Google Scholar
  15. Nordhaus, W. D. (1975). The political business cycle. Review of Economic Studies, 42(2), 169–190.CrossRefGoogle Scholar
  16. Scott Findley, T. (2015). Hyperbolic memory discounting and the political business cycle. European Journal of Political Economy, 40(1B), 345–359.CrossRefGoogle Scholar
  17. Smets, F., & Wouters, R. (2003). An estimated dynamic stochastic general equilibrium model of the euro area. Journal of the European Economic Association, 1(5), 1123–1175.CrossRefGoogle Scholar
  18. Smets, F., & Wouters, R. (2007). Shocks and frictions in US business cycles: A Bayesian DSGE approach. American Economic Review, 97(3), 586–606.CrossRefGoogle Scholar
  19. Wingrove, R. C., & Davis, R. E. (2012). Classical linear-control analysis applied to business-cycle dynamics and stability. Computational Economics, 39(1), 77–98.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2017

Authors and Affiliations

  • Gopal K. Basak
    • 1
  • Mrinal K. Ghosh
    • 2
  • Diganta Mukherjee
    • 3
    Email author
  1. 1.Stat-Math UnitIndian Statistical InstituteKolkataIndia
  2. 2.Department of MathematicsIndian Institute of ScienceBangaloreIndia
  3. 3.Sampling and Official Statistics UnitIndian Statistical InstituteKolkataIndia

Personalised recommendations