Electoral uncertainty, fiscal policy and macroeconomic fluctuations

In this paper we study the link between elections, fiscal policy and aggregate fluctuations. The setup is a stylized dynamic stochastic general equilibrium model incorporating both technology and political re-election shocks. The latter are incorporated via a two-party model with elections. The main theoretical prediction is that forward-looking incumbents, with uncertain prospects of re-election, find it optimal to follow relatively shortsighted fiscal policies, and that this hurts capital accumulation. Our econometric estimation, using U.S. data. finds a statistically significant link between electoral uncertainty and policy instruments and in turn macroeconomic outcomes. (C) 2006 Elsevier B.V. All rights reserved.