IDEAS home Printed from https://ideas.repec.org/p/cep/cepdps/dp0053.html
   My bibliography  Save this paper

Do Good or Do Well? Public Debt Management in a Two-Party Economy

Author

Listed:
  • G Milesi-Feretti

Abstract

Policy rules can be welfare improving if the government faces a time inconsistency problem when it chooses its optimal policy sequentially. In this paper I show that a conservative government, while favourable in principle to the institution of binding policy rules, may rationally choose not to do so in the presence of electoral competition. The reason is that left-wing governments typically face more serious time inconsistency problems than right-wing ones, because of incentives to raise revenue through inflation or tax capital for distributional reasons. A binding rule may make the left-wing party more "credible" in the eyes of the voters, conversely in the absence of rules, voters will favour the conservative party- for example because of its stronger anti-inflationary preferences. I develop this idea in the context of a simple debt management model, in which the incumbent can decide whether to roll over a given amount of debt in nominal form or indexing debt to the price level. An election follows, and after the election the new government has to repay the debt using taxes and inflation, both assumed to be distortionary. The right-wing party attributes a higher weight to the inflation tax distortion than the left-wing party; the median voter's preferences are in-between the two parties'. Also, both parties face a fixed cost of being out of power. In the absence of a commitment technology, nominal debt will artificially enlarge the inflation tax base, since after the election the government will take nominal interest rates as given and try to reduce the real value of its obligations through inflation. With rational expectations and full information, once the indexation parameter is chosen, voters know who will fully incorporate future inflation. As a result, inflation is too high and taxes too low. If the costs of inflation are convex, voters will be more likely to choose the right-wing party if debt is nominal. The results extend to a setting in which parties differ in their preferences for private vs public consumption. In the presence of uncertainty, a party in power will face a trade-off between the incentive to "tie the hands" of its eventual successor in case of an election loss ("do good") and the incentive to make its opponent look "bad" in the eyes of the voters in order to win the election ("do well").

Suggested Citation

  • G Milesi-Feretti, 1991. "Do Good or Do Well? Public Debt Management in a Two-Party Economy," CEP Discussion Papers dp0053, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp0053
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Blanchflower, D. & Oswald, A., 1990. "What Makes A Young Entrepreneur?," Papers 373, London School of Economics - Centre for Labour Economics.
    2. Victor R. Fuchs, 1982. "Self-Employment and Labor Force Participation of Older Males," Journal of Human Resources, University of Wisconsin Press, vol. 17(3), pages 339-357.
    3. Evans, David S & Jovanovic, Boyan, 1989. "An Estimated Model of Entrepreneurial Choice under Liquidity Constraints," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 808-827, August.
    4. Kanbur, S M Ravi, 1982. "Entrepreneurial Risk Taking, Inequality, and Public Policy: An Application of Inequality Decomposition Analysis to the General Equilibrium Effects of Progressive Taxation," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 1-21, February.
    5. Kihlstrom, Richard E & Laffont, Jean-Jacques, 1979. "A General Equilibrium Entrepreneurial Theory of Firm Formation Based on Risk Aversion," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 719-748, August.
    6. Grossman, Gene M, 1984. "International Trade, Foreign Investment, and the Formation of the Entrepreneurial Class," American Economic Review, American Economic Association, vol. 74(4), pages 605-614, September.
    7. Bruce D. Meyer, 1990. "Why Are There So Few Black Entrepreneurs?," NBER Working Papers 3537, National Bureau of Economic Research, Inc.
    8. Moore, Robert L, 1983. "Employer Discrimination: Evidence from Self-Employed Workers," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 496-501, August.
    9. Edward P. Lazear & Robert L. Moore, 1984. "Incentives, Productivity, and Labor Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 99(2), pages 275-296.
    10. Marc Bendick Jr. & Mary Lou Egan, 1987. "Transfer Payment Diversion for Small Business Development: British and French Experience," ILR Review, Cornell University, ILR School, vol. 40(4), pages 528-542, July.
    11. George J. Borjas, 1986. "The Self-Employment Experience of Immigrants," Journal of Human Resources, University of Wisconsin Press, vol. 21(4), pages 485-506.
    12. Rees, Hedley & Shah, Anup, 1986. "An Empirical Analysis of Self-employment in the U.K," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 1(1), pages 95-108, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Rune Jansen Hagen & Gaute Torsvik, 2007. "Irreversible Investments, Dynamic Inconsistency and Policy Convergence," CESifo Working Paper Series 1910, CESifo Group Munich.
    2. Uhlig, Harald, 1997. "Long Term Debt and the Political Support of a Monetary Union," CEPR Discussion Papers 1603, C.E.P.R. Discussion Papers.
    3. Caselli, Francesco, 1997. "On the distribution of debt and taxes," Journal of Public Economics, Elsevier, vol. 65(3), pages 367-386, September.
    4. Nuno Ribeiro & Susana Jorge & Mercedes Cervera, 2013. "Estudo do Endividamento da Administração Local Portuguesa: Evidência Empírica USando Modelos de Análise de Dados em Painel," Notas Económicas, Faculty of Economics, University of Coimbra, issue 38, pages 46-67, December.
    5. Leopoldo Fergusson & James A. Robinson & Ragnar Torvik & Juan F. Vargas, 2016. "The Need for Enemies," Economic Journal, Royal Economic Society, vol. 126(593), pages 1018-1054, June.
    6. Jonsson, Gunnar, 1997. "Monetary politics and unemployment persistence," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 303-325, July.
    7. Javier Salinas, 1998. "The Constitutional Political Economy of Public Deficits: The Spanish Case 1," Constitutional Political Economy, Springer, vol. 9(3), pages 235-249, September.
    8. Hagen, Rune Jansen, 2002. "The electoral politics of public sector institutional reform," European Journal of Political Economy, Elsevier, vol. 18(3), pages 449-473, September.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cep:cepdps:dp0053. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.