Strategic Borrowing in Competitive Elections

Abstract

This article examines the effect of a government's popularity on its incentives to increase the budget deficit before an election. It thus adds further insights to an expanding literature on context-conditional political budget cycles, i.e. pre-election dynamics in the budget balance under different political, economic, and institutional settings. In particular, the article refines previous analyses with a similar emphasis, arbitrates between competing theoretical models of political budget cycles, and integrates hitherto separate theories in a unified model predicting the impact of government popularity on the magnitude of electorally motivated deficits. The main substantive result is that party polarisation mediates the relationship between government popularity and the deficit. When polarisation is low, the effect is parabolic with the maximum occurring at the point where the election is neck-on-neck. As polarisation increases, the effect approaches linearity where a lower popularity implies a higher deficit. This result is underpinned by an empirical investigation of 19 OECD countries.

Keywords: Political budget cycles, Vote intention, Developed democracies

JEL Classification: D72, E62, D78