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By Siavash Mohades
The political economy literature has studied an unconventional yet reasonable explanation for the increasing trend of rise in government debt. Prior to elections, governments (and multi-partisan parliaments) usually increase welfare policies and budget expansions to attract votes and hence the continuation of their power. Essentially, and in each election cycle, 1) the expansion programs by the parties in charge and 2) the promises of budget expansion by the rival parties can induce direct and indirect rises in government debt.
© Boom times. Artem Aleshko
The political economy has remained relatively silent in publicly clarifying the role of the political business cycle in the decades of the rise of government debts. This type of cycle refers to a macroeconomic cycle that is induced by the political cycle (elections) and is initiated by an external intervention of political actors.
Before digging into the theoretical role of such cycles in the (over)expansion of governments’ budgets, let us take a look the Government Debt / GDP series from the U.S. economy. Note how each recession increases the ratio. We will discuss such responses of government when we introduce the theory of the tragedy of commons.
Total public debt as per cent of GDP. Shaded areas indicate US recessions. © U.S. Office of Management and Budget and Federal Reserve Bank of St. Louis
Motivation for such a cycle comes from the impression that the incumbent government may benefit from a good macroeconomic cycle; either to increase its chances of being re-elected or the rival party induces a positive cycle, based on the expectations of the public from macroeconomic conditions.
On the other hand, once the opposition party is in charge, it awaits an electoral cycle to expand the government’s budget and gain votes. Suppose that the loop is not interrupted by constitutional limits, such as fiscal rules. In that case, it ends up in a large spiral of increasing public debt simply because politicians love remaining in power.
It is easy for the government to expand a budget it does not really have to commit to, especially when the credibility of the government’s bonds is high.
Gambling on Government’s Balance Sheets to Attract Votes
The story of the business cycle is quite simple: political disagreement among parties leads to large expansionary programs and plans to gain votes through different partisan approaches (redistribution of welfare, military programs, etc.).
In essence, a democratic setting could entail a fiscal policy path without long-term fiscal rules chosen sequentially without commitment. The Partisan Conflict Index tracks the degree of political disagreement among US politicians at the federal level.
The historical data of this index demonstrates a steady increase in political polarisation among American politicians. Confronting this trend with the public debt-to-GDP ratio could partially explain the increase in the Public Debt/GDP.
The theory of the tragedy of commons identifies the impact of an increase in political polarisation on the long-term trend in government debt in a democratic setting. These tragedies engage the incumbent politician in excessive and extreme fiscal measures that lead to long-term costs of excessive government debt and fiscal commitments.
Take the case of the recent pandemic - as we all observed at its most stringent - some governments increased their debt to finance new short and long-term commitments in their education, medical sector and pension schemes. In most cases, the extreme measures were justified by extreme circumstances.
A long-term-looking fiscal rule can prevent the harm that might come from the government’s actions and internalise the total cost of the additional debt because the burden of this debt will be shared with future governors.
In other words, a coordination problem can occur across the fiscal independence countries under the monetary union umbrella, especially in a shared interest rate system like the European Union.
The Failed Gambling for the Society: Public Debt Explosion
When a higher political polarisation is combined with smaller margins in the elections, the party-in-power might prefer that future governments be fiscally responsible, mainly because the incumbent party can neither benefit from spending in the future nor be responsible for repayments of the debt.
Assuming fiscal responsibility of the future office, the incumbents expand the fiscal policy by small margins each time they need to induce a political cycle.
All in all, while inflation might be a forgotten issue in the upcoming years - especially given the speculations of an economic recession in the near future - high public debts and short-term inflations will still haunt the European and other democratic economies.
Moreover and in a monetary union like the Eurozone, it is crucial to keep politicians responsible for their big impossible dreams and promises. Their induced cycle might harm other states too, as both inflationary and debt-increasing impacts of large expansions are potentially hazardous for the whole monetary and fiscal system of the union.
Sources: Journal of Monetary Economics, Journal of political Economy, Journal of Economic Perspectives
Written by Siavash Mohades
March 2023
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