Leaping into the Dark: A Model of Policy Gambles

57 Pages Posted: 20 Sep 2021 Last revised: 2 Dec 2022

See all articles by Kartik Anand

Kartik Anand

Deutsche Bundesbank

Prasanna Gai

University of Auckland Business School; Australian National University (ANU); Bank of England

Philipp Koenig

Deutsche Bundesbank

Date Written: September 10, 2021

Abstract

We examine why rational voters support risky ``policy gambles'' over a safe status quo, even when such policies are detrimental to welfare. In a model of electoral competition, investors finance domestic projects in exchange for a stake in future output, while voters receive the remaining output. Government policy influences the riskiness of projects' output. However, when investors invest, the incumbent cannot pre-commit to retain the status quo policy into the future. Instead, the policy is determined subsequently in an election where voters can increase their expected output by voting for policy gambles. Our analysis highlights how investors' self-fulfilling beliefs interact with the distribution of output in abandoning the status quo. We argue that institutions that foster political consensus can eliminate the gamble equilibrium and raise welfare.

Keywords: Policy uncertainty, electoral competition, multiple equilibria, political consensus

JEL Classification: D72, D78, P16

Suggested Citation

Anand, Kartik and Gai, Prasanna and Koenig, Philipp, Leaping into the Dark: A Model of Policy Gambles (September 10, 2021). Available at SSRN: https://ssrn.com/abstract=3925078 or http://dx.doi.org/10.2139/ssrn.3925078

Kartik Anand

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

HOME PAGE: http://www.bundesbank.de/research_kartik_anand

Prasanna Gai

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
+020 7601 3583 (Phone)

Philipp Koenig (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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