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10.6.2 Long-run implications of the Nordhaus model

Where incumbent politicians are concerned about their re-election prospects,

the Nordhaus model predicts that ‘democratic systems will choose a policy

on the long-run trade-off that has lower unemployment and higher inflation

than is optimal’. This outcome is the result of the following behaviour.

Suppose before an election the economy is located at point G in Figure 10.3.

The incumbent government can increase its chances of re-election by engineering

an expansion of the economy and move up the short-run trade-off SG

to point E1. This represents the best position that the government can achieve

since SG is tangential to V1 at E1. Since E1 lies to the left of the LRPC,

equation (10.3) indicates that SG will shift up to the right as expectations

adjust to the higher rate of inflation. In contrast, if the short-run electoral

outcome position lay to the right of LRPC, the incumbent party could improve

its popularity by policy choices which move the economy back to a

position on the LRPC. The long-run dynamics of the Nordhaus model over

the course of many elections are shown in Figure 10.4, where E0E0 is the

election outcome locus. The long-run equilibrium is determined where E0E0

intersects the LRPC at E* = M. Since M is on both the LRPC and SM, ‘the

incumbent party cannot improve its performance by moving along the shortrun

trade-off curve’ because SM is also at a tangent to the iso-vote contour V4

(Nordhaus, 1975). The flatter the short-run Phillips curves, the higher will be

the steady state equilibrium rate of inflation.

The interesting outcome of opportunistic behaviour over many electoral

regimes is that the long-run solution to the model corresponds to the myopic

position M. Thus democratic systems are predicted to produce a steady state

equilibrium with higher inflation and lower unemployment than is optimal,

Figure 10.4 The long-run solution in the Nordhaus model

that is, an inflation bias (with λ = 1 and a vertical Phillips curve, the outcome

involves an inflation bias only).