Voting and Volatility

• Author: Christian Ebeke and Dilan Ölçer
• Position: Ebeke an Economist in the IMF's European Department, and is an Economist at the Riksbank, Sweden's central bank.

Economists have established that erratic taxing and spending policies hurt long-term growth and the overall welfare of a society (Fatás and Mihov, 2003; 2013).

One source of that policy volatility can be election related. As part of their reelection effort, incumbents can manipulate economic policy instruments. Among other things, they raise public spending and run budget deficits to increase overall demand and create jobs (even on a temporary basis)—and boost their election prospects.

But the preelection excess can be followed by a postelection hangover. Governments often have to go on an austerity plan to offset their free-spending preelection policies. This politically generated boom-bust cycle can hurt long-term economic growth and stability.

Preelection priming of the economy occurs mostly in developing countries (Shi and Svensson, 2006). We concentrated on low-income countries—those with annual per capita gross national product below $1,175 and without durable and substantial access to international financial markets. Over a 21-year period, we found strong evidence of such election-induced cycles in 68 low-income countries. In the year before the election, current spending and deficits grew. In the aftermath, to rebuild the buffers they depleted, governments cut investment spending and raised some taxes. We also explored two potentially important constraints on the ability of an incumbent to pursue a politically motivated fiscal agenda in an election year—fiscal rules, which set explicit targets for budgets, and IMF programs, which include explicit fiscal targets. We found that both significantly dampen the magnitude of the political budget cycle.

Political business cycles

Empirical studies of the political business cycle from the 1970s until the 1990s focused almost entirely on advanced economies, where generally researchers have not found statistically significant evidence of such cycles. More recent studies, however, that looked at current government expenditures, indirect tax revenues, and budget deficits found evidence of politically driven economic cycles in developing economies.

Most of these studies did not explicitly focus on low-income countries, but pooled together all developing countries—low and middle income. Moreover, although they studied what happens to specific variables during elections, they did not provide robust analysis of the composition of the postelection adjustment.

We focused on low-income countries...