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Making rules credible: divided government and political budget cycles

Abstract

Political budget cycles (PBCs) can result from the credibility problems office-motivated incumbents face under asymmetric information, due to the temptation to manipulate fiscal policy to increase their electoral chances. We analyze the role of rules that limit public debt, because borrowing is a necessary condition for aggregate PBCs. Since the legislature must typically authorize new debt, divided government can make these fiscal rules credible. Commitment is undermined by either unified government or imperfect compliance with the budget law, which can help explain why PBCs are stronger in developing countries and in new democracies. When divided government affects efficiency, voters must trade off electoral distortions and government competence.

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Notes

  1. While our focus is on the credibility of rules, Lohmann (1998b) and Keefer and Stasavage (2003) make a related point on the credibility of delegation: an independent central bank, the Rogoff (1985) solution to the time consistency problem of monetary policy, is not credible unless there are political veto players that can block executive action.

  2. Though we could employ a general strictly concave function, this specification generates a closed form solution for the benchmark model, and simplifies the evaluation of expectations.

  3. In Rogoff (1990) there is no debt, but the incumbent can reduce capital expenditures, not visible to voters at election time, to boost consumption expenditures and reduce taxes. Though there is no explicit restriction on how shocks affect the different components of the budget, there is no distinction between the tax burden and tax collection, and the expenditures on public consumption goods are equal to their provision. Hence, in the final analysis the implicit restriction is that competence shocks determine how government expenditures are transformed into the provision of capital goods.

  4. The Appendix is available as supplementary material.

  5. This assumption rules out end-period problems, since parties will always be interested in winning the upcoming election. This is consistent with Aldrich (1995) and the literature on how parties solve collective action problems.

  6. This perspective is applied more often to European, Asian and Latin American democracies, where the executive can issue decrees unilaterally, than to the United States (McCubbins et al. 2007:1680). The case of presidential systems wherein the legislature can amend the executive’s proposal, so the legislature has the agenda setting power, is reviewed later.

  7. As in the reasoning of Kayser and Wlezien (2005) on how economic voting is more important when political polarization is low, this requires some voters with a degree of ideological polarization small enough to assure that the economic vote predominates.

  8. Another possibility in a parliamentary setting is to introduce a small third party, C, that is favored by the median voter. This party will be needed by either major party A or B to form a coalition government.

  9. Persson and Tabellini (2000:420–425) characterize models such as Lohmann’s (1998a) as moral hazard models of electoral cycles, in contrast to the adverse selection models developed by Rogoff and Sibert (1988), Rogoff (1990), and Persson and Tabellini (1990) where electoral cycles are a signal of the competence of the incumbent. If the incumbent does not have private information about its own competence, but asymmetric information on the choice of policy instruments remains, the moral hazard problem discussed in the text comes to the forefront.

  10. The term “indices” is used in semiotics for signs that are the consequence of some cause. In our setting, the provision of public goods and the tax burden are indices of government competence.

  11. Our timing à la Lohmann (1998a) differs from the Rogoff (1990) timing where the incumbent decides the budget allocation after observing its competence shock, not before. Rogoff has a signaling model, where the competence shock affects the optimal choice of taxes and public consumption spending.

  12. A more precise, but tedious, notation would define a probability measure over ω that represents voters’ beliefs, and then apply Bayes’ rule to update them. However, in equilibrium this probability measure will be degenerate, with all the mass in the true ω, which justifies the notation in the text. The same applies to \(\hat{\theta}\) and \(\hat{\varepsilon}\).

  13. See (39) in Hanusch (2010). We take the case q=0, since this fits our framework with two parties, where the major party may win votes only at the expense of the smaller coalition party. Hanusch also has a case q=1 where the major party may also win votes at the expense of a third party outside the governing coalition.

  14. Though Alesina et al. (1997) state there are no opportunistic cycles in the United States, Grier (2008) finds instead clear evidence of opportunistic political business cycles by using a wider range of control variables. Furthermore, he is able to link these cycles to monetary policy, but not to fiscal policy.

  15. In our framework, the credit for good performance in election years accrues to the president. Even if performance reflected the competence of both branches of government, the results in Hanusch (2010) imply that most of the credit would still go to the president. Hence, Congress has no incentive to engage on its own in PBCs.

  16. Saporiti and Streb (2008) look at how separation of powers in presidential systems moderates PBCs, but the legislature is never aligned with the executive because it acts benevolently as a representative of the people. This assumption rules out by construction the possibility of unified government.

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Acknowledgements

We greatly benefited from insightful suggestions made by the editor, William Shughart, and two reviewers, as well as from conversations with Alejandro Corbacho, Sybil Rhodes, Alejandro Saporiti and Javier Zelaznik. We appreciate comments by Jorge Baldrich, Maurício Bugarin, Daniel Heymann, Cecilia Rumi and participants at the meetings of the Banco Central del Uruguay, of the Asociación Argentina de Economía Política, of the Sociedad Argentina de Análisis Político and of the Econometric Society at Rio de Janeiro. We acknowledge support from the Agencia Nacional de Promoción Científica y Tecnológica of Argentina (PICT 34790 Préstamo BID 1728/OC-AR).

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Streb, J.M., Torrens, G. Making rules credible: divided government and political budget cycles. Public Choice 156, 703–722 (2013). https://doi.org/10.1007/s11127-012-9923-2

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  • DOI: https://doi.org/10.1007/s11127-012-9923-2

Keywords

  • Political budget cycles
  • Unified government
  • Rules
  • Credibility
  • Divided government

JEL Classification

  • D72
  • D78
  • H60