Monetary policy is perceived to affect elections
As economic outcomes are jointly determined by monetary and fiscal policy, and economic outcomes, in turn, determine voters’ choice at the ballot box, is it the case then that monetary policy affects the political fortunes and incentives of the elected executive? Dziuda and Pflueger in this paper develop a model examining how a central bank can affect the election prospects as well as the accountability of the elected executives. They use a two-period model with three groups of agents: the central bank, the government, and voters. The apolitical central bank trades off higher inflation against unemployment along a standard expectational Phillips curve. Voters, on the other hand, seek to minimize a period-2 social loss function that places a heavier weight on unemployment.
[W]e show that a central bank that relatively cares more about inflation than about fighting unemployment has negative impacts on political selection and accountability, as lower quality incumbents are reelected and governments exert less effort to fight unemployment. As a result, average unemployment is higher than it would be under a central bank that conducts a more inflationary policy.
A Model of Politics and the Central Bank
Authors: Wioletta Dziuda, Carolin Pflueger
From: University of Chicago
Historical evidence from OECD countries
In this paper, Javorcik et al. look at short-term nominal interest rates over the 1972-2010 period, for 19 OECD countries. Included in the sample are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Italy, Iceland, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, the United Kingdom and the United States.
Over the 1972-2010 period, Taylor rule specifications do not suggest a relationship between government ideology and monetary policy as measured by the short-term nominal interest rate or the rate of monetary expansion minus GDP trend growth. Monetary policy was, however, associated with government ideology in the 1990s: short-term nominal interest rates were lower under leftwing than rightwing governments when central banks depended on the directives of the government and exchange rates were flexible. Very independent central banks, however, raised interest rates when leftwing governments were in office.
Government Ideology and Monetary Policy in OECD Countries
Authors: Beata Smarzynska Javorcik, Luisa Doerr, Niklas Potrafke
From: University of Oxford, Center for Economic Studies and Ifo Institute
