Working Paper: CEPR ID: DP79
Authors: Patrick Minford
Abstract: The thesis of this paper is that political differences between parties are a major explanation of inflation and variations in it, and therefore introduce into real interest rates a risk premium which will vary with creditors' exposure to 'inflationary default', i.e., with the level of public debt. The paper tests a number of predictions of this theory. First, that political parties do differ in their policy behaviour (contrary to the median voter theorem); this is clearly supported by postwar evidence for the United Kingdom, West Germany and Sweden. Second, expected real interest rates on bonds are related to budget deficits and/or public debt, according to evidence for the United States and United Kingdom from 1920 to 1982. Third, we find some modest but (as we expected from the indirectness of the relationship) rather weak evidence of a connection between which party was in power and the level and variability of inflation in the same period for these two countries. Fourth, the theory provides a rationale for the commonly observed relationship between inflation and its variability.
Keywords: fiscal deficits; public debt; inflation; political parties
JEL Codes: 320; 134; 025
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Political differences between parties (D72) | inflation (E31) |
| Political differences between parties (D72) | variability of inflation (E31) |
| Political differences between parties (D72) | risk premium in real interest rates (E43) |
| public debt levels (H63) | risk premium in real interest rates (E43) |
| Budget deficits (H62) | expected real interest rates on bonds (E43) |
| Public debt (H63) | expected real interest rates on bonds (E43) |
| Party in power (D72) | level of inflation (E31) |
| Party in power (D72) | variability of inflation (E31) |