“The theory of the political business cycle, which analyzes the interaction of political and economic systems, arose from the obvious facts of life that voters care about the economy while politicians care about power.” (Nordhaus, 1989 p.1).
The PBC approach of Nordhaus (1975) emphasizes exclusively the electoral motivations of policymakers. All politicians simply maximize their chances of remaining in oflice and subsequently follow identical policies. Nordhaus' PBC is based upon two crucial assumptions. First, the voters are backward-looking and short-sighted; they vote for the incumbent if the economy is doing well' (low unemployment, high growth, low inflation) immediately before the elections. They forget quickly about the past and do not understand the economic relationship between inflation and unemployment. Second, the economy is characterized by a Phillips curve which is easily exploitable because of backward- looking expectations. In this context, every incumbent stimulates aggregate demand before elections. In addition, given that the inflationary consequences of an expansion are normally lagged, the stimulus can be timed in such a way that inflation will only appear after the election. At that time inflation is brought under control by a demand induced recession, which voters soon forget in time to be fooled again before the following election.
Recent work by Cukierman and Meltzer (1986), Rogoff (1987), and Rogoff and Sibert (1988) builds a 'rational political business cycle' theory (henceforth, RPBC). They show that Nordhaus' (1975) insights may survive even when voters are not myopic and gullible as long as they are imperfectly informed about some characteristics of the environment, the policymaker's objectives, or his ability to manage the economy. For instance, immediately before elections, incumbents may want to appear as 'efficient' as possible in providing new public goods, services, or transfers. By 'hiding' or delaying the budgetary...
Please join StudyMode to read the full document