ELECTORAL UNCERTAINTY, THE DEFICIT BIAS ANDTHE ELECTORAL CYCLE IN A NEW KEYNESIANECONOMY

Recent attempts to incorporate optimal fiscal policy into NewKeynesian models subject to nominal inertia, have tended to assume that policymakers are benevolent and have access to a commitment technology. A separateliterature, on the New Political Economy, has focused on real economies wherethere is strategic use of policy instruments in a world of political conflict. Inthis paper we combine these literatures and assume that policy is set in a NewKeynesian economy by one of two policy makers facing electoral uncertainty (interms of infrequent elections and an endogenous voting mechanism). The policymakers generally share the social welfare function, but differ in their preferencesover fiscal expenditure (in its size and/or composition).We use this model to examine three issues that arise from either literature.First, we consider the extent to which electoral competition gives rise to adebt or deficit bias, as one party seeks to win elections and tie the hands ofa potential successor, when all debt is defined in nominal terms. Second, weexamine the extent and nature of the electoral cycle introduced by having twoparties reflecting different preferences over either the composition or amountof government spending. Third, we examine whether electoral competition hasany impact on the conventional business cycle stabilisation policy, compared tothe standard analysis that assumes a single benevolent government....