Working Paper: CEPR ID: DP17626
Authors: Marina Halac; Pierre Yared
Abstract: We propose a political economy mechanism that explains the presence of fiscal regimes punctuated by crisis periods. Our model focuses on the interaction between successive deficit-biased governments subject to i.i.d. fiscal shocks. We show that the economy transitions between a fiscally responsible regime and a fiscally irresponsible regime, with transitions occurring during crises when fiscal needs are large. Under fiscal responsibility, governments limit their spending to avoid transitioning to fiscal irresponsibility. Under fiscal irresponsibility, governments spend excessively and precipitate crises that lead to the reinstatement of fiscal responsibility. Regime transitions can only occur if governments' deficit bias is large enough.
Keywords: Fiscal Policy; Deficit Bias; Political Economy
JEL Codes: C73; D02; D82; E6; H1; P16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government spending (H59) | fiscal regime (E63) |
| fiscal shocks (E62) | fiscal regime (E63) |
| deficit bias (H62) | fiscal regime (E63) |
| deficit bias (H62) | fiscal shocks (E62) |
| fiscal regime (E63) | fiscal regime transition (E63) |