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10.4 Politicians and Stabilization Policy

This ‘Downsian’ view of politicians indicates that government should be

viewed as endogenous in macroeconomic models (see Downs, 1957). According

to Frey (1978), the traditional Keynesian circular flow model needs

to be modified to take account of self-interested government behaviour. The

politico-economic system resulting from this modification is illustrated in

Figure 10.2. There is no doubt that following the Keynesian revolution voters

have increasingly held governments responsible for the state of the economy.

But in choosing to whom they will delegate decision-making power, voters

are faced with a principal–agent problem since the agent (government) may

have different preferences which it can conceal from the imperfectly informed


As is evident from Figure 10.2, in the politico-economic circular flow

model politicians are seen to be driven by a balance of both ideological and

re-election considerations. Voters evaluate politicians on the basis of how

Source: Adapted from Frey (1978).

Figure 10.2 A politico-economic model

successful they have been in achieving desirable economic goals such as high

employment, low inflation and rapid growth of real disposable incomes. The

state of the economy in the immediate pre-election period is crucial and

politicians are obviously aware that in order to survive in government it is

preferable to have a buoyant economy. If economic conditions are unfavourable,

voters may well choose to elect the opposition party and the incumbents

lose office. Meanwhile the opposition party makes attractive promises to the

electorate (recall, for example, George Bush Sr’s famous 1988 pre-election

pledge. ‘Read my lips, no new taxes’). Hence economic conditions influence

election results and the incentive to get elected directly influences the choice

and use of macroeconomic policies.

Politicians are also driven by partisan considerations, but ideological programmes

cannot be implemented unless parties first of all win or maintain

power. During the past 25 years a considerable amount of empirical work has

been undertaken to test the importance of key macroeconomic variables

(such as inflation, unemployment and the growth of disposable income) for

the popularity of governments. This work indicates that such macroeconomic

variables are statistically significant and have an important influence on

election outcomes (see Kramer, 1971; Tufte, 1975, 1978; Mosley, 1978; Fair,

1988; Schneider and Frey, 1988). Given that incumbent politicians occupy a

position similar to that of a monopolist with respect to the supply of policies,

it is hardly surprising that they may often succumb to temptation and use

discretionary policies in order to maximize their re-election prospects.

During the past 20 years or so economists have produced a rich array of

politico-economic models which incorporate many of these considerations.

The interdependence between the economy and the polity is now a wellestablished

area of research for economists interested in identifying the

underlying causes of aggregate instability. This research has attempted to

answer a number of interesting questions, for example:

1. how important are economic factors in influencing voter choice? (Frey

and Schneider, 1978a, 1978b);

2. do opportunistic politicians manipulate the economy for political profit?

(Nordhaus, 1975);

3. do ideological (partisan) considerations lead to political parties producing

a differentiated product? (Hibbs, 1977);

4. can political cycles exist in a world of rational non-myopic voters and

economic agents? (Alesina, 1987; Rogoff and Sibert, 1988);

5. does the empirical evidence provide support for politico-economic models?

(Alesina and Roubini with Cohen, 1997);

6. what are the policy implications of such models? (Alesina, 1989; Drazen,


In what follows we shall show how economists have attempted to answer

these and other questions.