Abstract
Motivation and methodExisting rational expectations models cannot satisfactorily explain why political budget manipulations systematically raise re-election chances and only occur in “specific contexts”. This paper offers a theoretical explanation by including unsophisticated voters into an opportunistic political cycle model; unsophisticated voters are unable to take the optimal behaviour of other agents (fully) into account, but may, nonetheless, vaguely suspect government deception.ResultsFirst, rationally expected manipulations are, on average, fruitless in equilibrium. By including unsophisticated voters we can, however, corroborate empirically found electoral effects of political budget manipulations. Second, unsophisticated voters become anxious and suspicious in an intransparent or uncertain world, but the government tries to “outperform” their scepticism by increasing budget manipulations in order to appear more competent and, ultimately, increase re-election chances. It is, therefore, not surprising that political budget cycles are observed in countries suffering from intransparencies such as developing countries or new democracies. Third and in addition, the model presented here predicts that political opportunism produces, unintentionally, a countercyclical policy effect in election years, thereby, for instance, alleviating the typical problem of policy procyclicality in developing countries.Additional contributionThe paper also offers a theoretical explanation for political distortions found in forecasts by US states. Based on overly optimistic revenue forecasts the incumbent state government can conduct expansionary fiscal policies in order to appear more competent prior to an upcoming election. Since the resulting deficit can only be observed afterwards, the government can effectively circumvent a constitutional balanced budget constraint. As a result, there are political forecast and budget cycles in the state. More generally, however, these findings may also apply to European countries where balanced budget constraints are or will be in place (for instance the debt brakes in Switzerland and Germany); similarly, they apply to the supra-national European Fiscal Compact of the European Union.
Highlights
It has become conventional wisdom that small deviations from rationality can make significant differences to economic equilibria as suggested by Akerlof and Yellen [1]
This paper introduces the concept of unsophisticated voters into the theoretical political cycle literature
A price may fulfil this role, but here there is no such variable which would allow the uninformed voters to extract the relevant information. – The rational expectations assumption for uninformed sophisticated voters explains why re-election chances cannot be improved without the existence of unsophisticated voters; this applies to [31] and it applies here, when the share of unsopisticated voters ψ is set to zero
Summary
It has become conventional wisdom that small deviations from rationality can make significant differences to economic equilibria as suggested by Akerlof and Yellen [1]. Akerlof and Yellen [1] define behaviour as near-rational, if a shock leads to first-order welfare effects for society, but only second-order losses for individuals who may exhibit “inertial behavior”, i.e. not respond fully rationally to the shock. They derive the rationale for near-rationality from the Envelope Theorem and present various examples from macroeconomics and industrial organisation. Those behavioural reasons are, for instance, asymmetric information, rationing due to efficiency wages, the use of rules of thumb involving money illusion, downward wage rigidity as implied by prospect theory, a lack in self-control as embodied in hyperbolic discounting, or the role of identity in explaining selfdestructive behaviour
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