Economic Policies and Elections. A principal-agent point of view

One of the most crucial lessons to be taken from the literature on electoral business cycles is that short-run electorally-induced fluctuations prejudice long-run welfare. Since the very first studies on the matter, authors have offered suggestions as to what should be done against this electorally-induced instability. As the government’s optimal policies depend crucially on the behaviour of voters, non-representative voting may, indeed, induce the government to behave as the representative of society’s interests. Given that elections are the appropriate mechanism to punish or to reward the behaviour of the incumbent, they can be used to turn voters, i.e. the public, into the principal who has all the incentives to motivate the government, as the agent, to choose appropriate economic policies. The paper analyses the circumstances under which an optimal contract can be established between the electorate and the government in order to guarantee that the government behaves in accordance with the true interests of society.