Institutions and Fiscal Policy

Dimensions of Fiscal Policy

Deficits and debt Speed of adjustment and overall debt

burden The overall size of government General versus targeted

expenditures Redistribution

Deficits

Why might a benevolent dictator run deficits?

Deficits

Why might a benevolent dictator run deficits? Finance capital projects Smooth tax rates and expenditures over

time Keynesian management: Borrow during

recession to stimulate demand.

Political institutions and debt

A finding that emerged in the 1980s: Coalition government and deficits

Causal logic?

Coalition governments and debt

“Overfishing the common pool.” Each party in the coalition is not

internalizing the full costs of the expenditure demands it makes

Solutions to this problem? “War of attrition” and delayed

stabilization When adjustment is needed, each party

believes the other should bear the costs.

Instability and deficits

Expected probability of reelection might be important

If I expect to be in power in the next period, I face incentives not to generate excessive deficits

But if I expect to lose, take everything and externalize the costs on successor Tie the hands of successors to prevent

them from making undesirable expenditures

Electoral budget cycles

Taxes fall and expenditures increase in election years.

How should we interpret this? Are voters gullible?

Can voters ever punish fiscal indiscipline? Do they?

What is the role of credit markets?

The size of government

Proportional representation versus SMD: Persson, Roland, Tabellini (2007), “Electoral

common pool problem”: Voters can discriminate between the parties of a coalition at the polls, but they cannot discriminate between factions of a single party government. This creates electoral conflict, and a common pool problem, within a coalition government but not within a single-party government.

The size of government

Presidential vs. parliamentary: P/T: Concentration of power in parliamentary

systems, checks and balances in presidential▪ Weaker accountability yields higher rents and

higher expenditures under parliamentary P/T: A story about legislative cohesion, no

confidence procedure:▪ In parliamentary regime, stable majority of

incumbent legislators can benefit from spending while externalizing the costs onto “outsiders,” while there is competition to get into the winning coalition in presidential systems

The size of government

Evidence: Appear to be large effects on size of

government for both More recent work (PRT 2007): The effect

of electoral rules flows through the number of parties/coalitions

General versus targeted expenditures

District magnitude: P/T 2000: Assume two parties who can

commit to their platforms. Larger districts diffuse electoral competition, forcing parties to seek support from broad coalitions. Small districts induce focus on narrow geographic constituencies▪ Similar story with different modeling strategy in

Lizzeri and Persico (2001). Similar story with far more complex model in Milesi-Ferretti, Perotti, and Rostagno (2002). Better empirics?

General versus targeted expenditures

Presidential versus parliamentary PRT (2000): Incumbent legislators elected

by retrospective voters in different districts. ▪ In parliamentary system, stable majority of

legislators pursues joint interests of its voters. This yields broad social transfers, public goods.

▪ Presidential system: No party discipline, interests of different minorities pitted against one another. Fleeting coalitions of special interest groups, districts.

Critiques?

What is missing?

What is missing?

More sophisticated understanding of presidentialism outside the USA

Partisan composition of legislatures Sort out district structure versus

electoral rules Party lists, internal party procedures Decree powers

Causality?

Causality?

Matching Instruments

Year of adoption of constitution Hall and Jones (1999) instruments▪ Latitude, % English speaking, % European

native tongue