Abstract
In the literature, it has been suggested that political budget cycles are context-conditional, i.e., do not occur in all countries or under all circumstances. What about the underlying economic conditions? It has already has been shown that recessionary expectations reinforce the political budget cycle. This paper argues theoretically that opportunistic policymakers expecting a recession during an election year allow the primary deficit to increase even more when the stock of debt is very high, but reduce the deficit by more during an expected boom (in an election year). For the empirical estimation we use panel data from Portuguese municipalities. Plots of average marginal effects for election years show that differences between high- and low-debt municipalities become more pronounced in stronger expected recessions as well as booms; the stronger effect on the deficit in high-debt municipalities is caused by changes on both the revenue and the expenditure side. A whole armada of robustness tests (non-linear effects, alternative specifications of excessive debt and forecasts, various methods to account for time effects and clustering, several sample restrictions) confirms our results.
Highlights
It is seen as a stylized fact that political budget cycles (PBCs) are context-conditional, i.e., they do not occur in all countries or under all circumstances
Our model shows that an opportunistic policymaker is immune to debt targets when a recession is expected during an election year
The goal of this paper was to show that it makes sense for policymakers of highly indebted local governments facing an election to raise the primary budget deficit beyond what policymakers dealing with a smaller stock of debt will do, when faced with a recession
Summary
It is seen as a stylized fact that political budget cycles (PBCs) are context-conditional, i.e., they do not occur in all countries or under all circumstances. Our model shows that an opportunistic policymaker is immune to debt targets (including a potential reputational loss) when a recession is expected during an election year Instead, such a policymaker is concerned about her electoral prospects, which improve if voters can be made to believe in her competence. The findings say that it may even be counterproductive to prescribe harsh medicine (higher tax rates), if the excessive-debt government faces frequent elections during recessionary periods Another interpretation relates to the role of fiscal constraints in the emergence of political budget cycles. 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. The model can be split into cycles of two periods consisting of election period t and off-election period ( t + 1)
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
