Governmental System and Economic Volatility in Democracies

AEI Economics Working Paper No. 2018-06

Johns Hopkins Carey Business School Research Paper No. 18-09

35 Pages Posted: 25 May 2018 Last revised: 23 Jul 2018

See all articles by Chen Cheng

Chen Cheng

Johns Hopkins University - Carey Business School

Christopher Li

Vanderbilt University

Weifeng Zhong

Mercatus Center at George Mason University

Date Written: June 6, 2018

Abstract

Economic volatility varies substantially across democracies. We study how the difference between federal and unitary systems of government can contribute to these variations. We show empirically that a higher degree of federalism is associated with less volatility in both economic growth and fiscal policy. Motivated by these stylized facts, we develop a macroeconomic model of policy-making at the central and district levels. Policy at the central level is uncertain due to uncertainty about the identity of the winning coalition in a legislature of district representatives, while policy at the district level is more stable due to homogeneity within districts. We show that, in equilibrium, the decentralization of policy-making powers can mitigate overall policy uncertainty. This implies less volatility in fiscal policy and, hence, less volatility in economic growth, compared to those in a more unitary system.

Suggested Citation

Cheng, Chen and Li, Christopher and Zhong, Weifeng, Governmental System and Economic Volatility in Democracies (June 6, 2018). AEI Economics Working Paper No. 2018-06, Johns Hopkins Carey Business School Research Paper No. 18-09, Available at SSRN: https://ssrn.com/abstract=3178204 or http://dx.doi.org/10.2139/ssrn.3178204

Chen Cheng

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Christopher Li

Vanderbilt University ( email )

Nashville, TN 37235
United States

HOME PAGE: http://christopherli.net

Weifeng Zhong (Contact Author)

Mercatus Center at George Mason University ( email )

3434 Washington Blvd., 4th Floor
Arlington, VA 22201
United States

HOME PAGE: http://www.weifengzhong.com/

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