The political economy of fiscal policy and inflation in developing countries : an empirical analysis

Most economists treat fiscal policy as exogenous and consider policymakers as machines to be programmed. Rarely do they seek to determine why, for instance, some countries rely on the inflation tax while others use direct taxation, let alone what political factors affect such decisions. Yet without a theory of how fiscal policymakers behave, at both the revenue and the expenditure levels, there is no guarantee that policy advice will turn out to be sound. The authors present the results of an empirical analysis of the political economy of fiscal policy for a group of developing countries. They look at alternative ways of incorporating political variables into the explanation of government policy actions. Dividing their results into three sections, one each for inflation, budget deficits, and devaluations, they find that: (a) the equilibrium inflation rate is higher the more citizens disagree about which party should hold office, and the more unlikely it is that the government currently in office will be reappointed; (b) political instability and polarization lead to a collective myopia that sometimes tempts policymakers to borrow too heavily and to leave the bills to their successors; and (c) governments tend to implement adjustment policies early in their tenure when they command political authority, but if political conflict arises, they may lack the strength to change the macroeconomic status quo and will resort instead to inflation and deficits.