Fiscal Policy, Public Debt Stabilisation and Politics: Theory and UK Evidence

Abstract

This paper presents a two-party model of fiscal and debt policy in which the parties do not care about policy outcomes when out of office. Unlike other models of this type, our model has predictions that are largely consistent with existing empirical findings about partisan and electoral effects on government expenditure, tax revenue, and debt. It also yields new predictions about how the feedback of fiscal policy on lagged debt may depend on partisan and electoral effects. These new predictions are not rejected by a test of the model on UK data. In multi-party democracies, the motives of the party in power undoubtedly affect fiscal and monetary policy. Many economists and political scientists believe that economic policy-makers are driven by two - not mutually exclusive - motives. First, they wish to remain in office as long as possible (the survival or opportunistic motive). Second, they wish to benefit their constituencies (partisan motive). The effects of these motives may show up in two ways in the data. First, there may be effects of ideological differences of the parties in power on fiscal and monetary policy - so-called partisan effects. For example, we might expect 'left-wing' governments to tax and spend more, and (possibly) accumulate more debt. Second, there may be attempts by the incumbent party to use fiscal and monetary policy to 'bribe' the electorate prior to elections e.g. by cutting taxes and interest rates - so-called electoral effects. Recent econometric work has established some interesting 'stylised facts' which are broadly consistent with these predictions. Several studies report evidence of electoral effects on various fiscal policy instruments for the United States; Tufte (I978) for transfers, Bizer and Durlauf (I990) for taxes, and MacDonald (i99i) for state-level public expenditure. More recently, Alesina et al. (I 992; I 993) have found evidence of electoral- effects on government debt in a panel study of OECD countries. Evidence of partisan effects on fiscal policy is scarcer. Alesina et al. (I 993) report partisan effects on debt, and Roubini and Sachs (I989) report in a study of OECD democracies that countries with a higher percentage of 'left-wing' governments have significantly higher longrun government spending to GNP ratios. Concurrently with the accumulation of this evidence, a theoretical literature, notably Alesina and Tabellini ( 1990), Rogoff ( 1990), and Rogoff and Sibert (i 988) has provided new explanations of observed electoral effects' on