The Economy and Political Budget Cycles

Abstract

Recent research has focused on the role of the political and institutional context for the occurrence of political budget cycles, i.e. fluctuations in the budget balance when elections loom. This study turns to the economic factors. A formal model predicts that higher economic volatility distorts political signals and thus dampens governments’ incentives to manipulate fiscal policy in an attempt to appear competent before an election. Economic volatility thus decreases the magnitude of the political budget cycle. This prediction receives strong empirical support from a time series-cross section analysis of 26 democracies between 1980 and 2008.

Keywords: Political budget cycles, Asymmetric information, Economic volatility

JEL Classification: D72, E62, D82