Fiscal Policy, Endogenous Political Uncertainty and Economic Fluctuations
31 Pages Posted: 22 May 2015
Date Written: August 16, 2014
Abstract
We argue that when fiscal policy is endogenously determined, the incentives of redistributive politics associated with its formulation can endogenously add to the uncertainty and volatility that an economy faces. In particular, small shocks may get translated into large fluctuations. Our analysis considers a dynamic model of fiscal policy formulation and redistributive politics in which the economy's fundamentals are subject to small and transitory shocks. Though optimal fiscal policy under commitment can insulate the economy from fluctuations, we show that under endogenous policy determined by majority rule voting, the economy can transition between states of high and low redistribution with concomitant fluctuations in investment and output.
Keywords: endogenous fiscal policy, redistributive politics, political uncertainty, economic fluctuations and volatility
JEL Classification: E62, E32, H31, D72, P16
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