شوک های سیاسی و بدهی های عمومی : موردی برای بازبینی محافظه کارانه بانک مرکزی

We explore the dynamics of public debt and optimal institutions in the presence of political shocks arising from electoral uncertainty. Under commitment, optimal stabilization is established by combining an inflation target with a debt target. The inflation target should be contingent on the political shocks while the debt target forces the government to fully absorb the political shocks in the period in which it occurs. In the absence of such inflation and debt targets but with monetary commitment, a conservative central bank enhances stabilization. An even more conservative central bank is optimal if monetary policy cannot commit.

Research into political monetary cycles goes back to Hibbs’ (1977) work on the relationship between the inflation-unemployment trade off and the political color of the government. Later work includes Alesina (1987), as well as a number of papers that suggest institutional reforms to alleviate politically induced cycles in monetary policy (see, e.g., Alesina and Gatti, 1995, Muscatelli, 1998 and Al-Nowaihi and Levine, 1998). More recent work links political monetary cycles to fiscal policy (see, e.g., Demertzis et al., 1999, Ozkan, 2000, Pina, 2000 and Drazen, 2001).1 The current paper extends the work on political monetary cycles and fiscal policy by incorporating public debt. The existing literature either employs a single-period setting or assumes a balanced government budget in each period. The introduction of public debt raises both positive and normative issues. Positive questions are how shocks should be spread out over time and whether the intertemporal transmission of political shocks (the news that a new government has been elected) differs from that of standard supply shocks. A normative issue involves the way public debt affects optimal institutional design, including that of the central bank. Are also fiscal restrictions called for and, if so, how do political shocks affect these optimal restrictions? To explore these issues, we extend the standard Barro and Gordon (1983) framework with both fiscal policy and political shocks arising from electoral uncertainty. The political structure is characterized by two political parties that differ in their preferences about the level of government spending. This type of conflict has received only little attention in the literature on political monetary cycles, even though in reality political parties often differ strongly in their views on the desirable size of the public sector.2 Our formulation of the conflict extends Pina (2000) by formulating a dynamic two-period model in which public debt is endogenous.3 We start the analysis with the case in which the central bank can commit to monetary policy. While commitment is less realistic than discretion, it enables us to gain insights into the impact of the distortion of political shocks before moving on to the more complicated situation in which discretion yields additional distortions. In this way, we conduct the normative analysis of welfare-enhancing institutional adjustments in several steps, in which we progressively strengthen the case for a conservative central banker (à la Rogoff, 1985), who attaches a larger preference weight to price stability than the rest of society does. Indeed, in contrast to the existing literature on central bank conservatism, we show that a conservative central bank may be optimal even if monetary policy can commit. The case of monetary commitment yields the following results. As regards the positive results, supply shocks and political shocks affect public debt in different ways. An adverse supply shock boosts public debt. The election of a government featuring a relatively high spending target, in contrast, is actually likely to reduce debt.4 Indeed, two forces exert downward pressure on public debt. First, such a government prefers high public spending also in the future. To create the financial room for this additional public spending, public debt accumulation is restrained. The second downward effect on debt is that, by financing the spending shock in the period in which it occurs, the government forces the central bank to absorb a larger part of the political shock immediately through an inflation surprise. The normative analysis shows that institutional adjustments can yield welfare gains under commitment, due to the distortions caused by the political shocks. We first consider a rich menu of institutional adjustments, which include shock-contingent inflation and debt targets, as well as the possibility to institute a conservative central bank. The modelling of the inflation target is similar to Svensson (1997). However, whereas Svensson's inflation target alleviates the standard ‘inflation bias’ due to discretion, the role of our inflation target is to better stabilize political shocks. In contrast to Svensson's inflation target, therefore, our inflation target depends on current shocks affecting the economy. In particular, under the optimal combination of institutional adjustments, the inflation target is tightened if a left-wing government assumes power so that the higher spending target of such a government does not cause inflation. Such an inflation target contingent on current political shocks makes central bank conservatism redundant.5 The optimal debt target ensures that the government must completely absorb the political shock in the period in which it occurs. Intuitively, the inflation and debt targets offset the political distortions associated with political shocks. In particular, these targets reduce the room to finance these shocks through inflation and adjustments in public debt. This forces governments to absorb political shocks through an adjustment of public spending in the direction preferred by society. Hence, relative to its own target, a left-wing government is forced to cut public spending in the period in which it comes to power, while a right-wing government is encouraged to raise spending. In practice, imposing fiscal restrictions proves to be difficult, especially when these restrictions should be contingent on shocks. If we exclude such debt targets, the optimal inflation target has to trade off combatting intratemporal and intertemporal policy distortions. Still, the central bank does not have to be made conservative. The reason is that the shock-contingent inflation target continues to be a richer instrument to fight political distortions than a conservative central bank. However, inflation targets that are contingent on political shocks may lack credibility and lead to misinterpretations by financial markets (see, e.g., Beetsma and Jensen, 1999). If we exclude not only shock-contingent debt targets but also shock-contingent inflation targets, a conservative central bank becomes optimal. Central bank conservatism is likely to be easier to implement because the optimal degree of central bank conservatism is constant over time and thus less subject to political interference. Nevertheless, political interference can never be completely excluded. To illustrate, before the European Monetary Union (EMU) was established, the signatories of the Treaty gave the European Central Bank (ECB) a mandate for price stability. Still, politicians may use their discretionary powers to appoint members of the Governing Council of the ECB to influence monetary policy. Waller, 1989 and Waller, 1992 explicitly models the appointment process of members of central bank boards, including the role of partisan politics in this process. The latter part of the paper relaxes the assumption of monetary policy commitment. Recent work by Dixit and Lambertini, 2003a and Dixit and Lambertini, 2003b has renewed interest in the modelling of the interactions between discretionary monetary and fiscal policies. Here, we extend existing analyses of these interactions in the absence of commitment by incorporating public debt and allowing for political shocks. Restricting ourselves (for reasons given earlier) to time-invariant institutional adjustments, the analysis reveals that a conservative central bank continues to be optimal under discretion. In fact, numerical analysis shows that under discretion the central bank should be even more conservative than under commitment. Intuitively, a conservative central bank combats not only political distortions but also the welfare losses due to the lack of policy commitment. The remainder of this paper is structured as follows. Section 2 presents the model. Section 3 explores the equilibrium under monetary commitment, while Section 4 analyzes optimal institutional arrangements for this case. Section 5 explores the equilibrium and optimal institutions under monetary discretion. Finally, Section 6 concludes the main body of the paper. The appendix derives the commitment solution in the absence of inflation and debt targets. The details of all derivations and the proofs are relegated to an Additional Appendix, which is available upon request or from the Internet.6

This paper extends existing work on political monetary cycles by including public debt in a model with political disagreement about the level of public spending. We derived a number of new results. First, whereas an adverse, temporary supply shock boosts public debt, the election of a government with a relatively large spending target is actually likely to reduce debt. The latter result originates in two factors. One is that such a government wants to leave enough resources for future spending. The other factor is the possibility to finance an unanticipated shock partly through an inflation surprise in the period in which it occurs. To alleviate the distortions due to the political shocks, society finds it optimal to impose debt and inflation targets that are contingent on the current political shock. These targets insulate monetary policy and debt policy from political shocks, thereby forcing fiscal policy to absorb the political shock entirely in the period in which it occurs. In the absence of such shock-contingent targets but with monetary commitment, a conservative central bank, which does not fully accommodate political shocks, is optimal. Hence, we provide a case for a conservative central bank even if monetary policy can commit. With monetary discretion, the optimal degree of conservatism rises further. The analysis can be extended into various directions. One possibility is to model the political process in a more elaborate way. For example, one might want to endogenize the electoral fortunes of our political parties by having them commit to a pre-electoral platform on the spending target followed by an explicit vote by individuals who feature hetereogeneous preferences on the level of spending. We conjecture that platforms would converge to some extent, thereby mitigating the political shock. However, if some electoral uncertainty unrelated to the specific platform remains, this convergence will not be perfect, as political parties (that may still win elections without fully converging to the median voter's preferences) want to avoid committing to a spending level that differs too much from their ideological preferences.