Disposable income, unemployment, inflation and state spending in a dynamic political-economic model

Abstract

This paper formulates a medium-term macroeconomic model of disposable income, unemployment, inflation and state spending, proposes a theory of qualitative choice to explain electoral popularity in terms of these variables and develops three approaches to the formulation of political-economic policy. The first approach is static, sets the tax rate to reconcile the interests of various pressure groups and yields a political trade-off between the private and public sector. The second approach relies on maximizing the probability of winning the next election and gives rise to a political business cycle unless the electorate votes strategically. The implications of crowding out of private investment under alternative monetary rules, autonomous behaviour of the state bureaucracy and tax-indexation for the political business cycle are also examined. The third approach analyzes the objective of maximizing the uninterrupted length in office. It yields a short-run political cycle superimposed on a longer cycle.