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Two essays on political economy

  • Economics
  • Political Science


C }. ~2 Discussion for a erEconomic Research CBM R 8414 1989 9 I Ilhql IIIII IlUll IIIINII INII I~I IIIII I~I INI No. 8909 TWO ESSAYS ON POLITICAL ECONOMY by Frederick van der Ploeg February , ~989 (i) The Political Economy of Overvaluation (ii) Election Outcomes and the Stockmarket THE POLITICAL ECONOMY OF OVERVALUATION r Frederick van der Ploeg CentER for Economic Research, Tilburg University Postbox 90153. 5~0 LE Tilburg, The Netherlands ABSTRACT This note reconsiders the political business cycle within the context of a small open economy. The incumbent government chooses its exchange rate policy to maximise votes on election eve where the popularity on election eve depends on how well the government has done on output, employment and real income. When there is a J-curve, a real appreciation immediately reduces inflation and increases real consumers' wages, whilst the impact on output is much more graduel. It then followa that the incumbent government udopts ei policy of tmmediate depreciation of the exchange rate on the morning after the election and subsequently implements gradual appreciations, so that output and real income gradually rise and inflation gradually falls over the election cycle. Towards election eve output might fall. Keywords: Political business cycle, J-curve, overvaluation. JEL classification: 131, 431. November 1987 Revised February 1989 . The author is grateful to an associate editor and an anonymous referee for their useful comments. 1 Most of the literature on political business cycles (e.g., Nordhaus, 1975; MacRae, 1977; van der Ploeg, 1984) assumes that the incumbent political party attempts to secure re-election, by maximisine the expected number of votes cast in its favour at the forthcoming election, and to exploit lags due to adaptive expectations. The government can then fool the electorate by judiciously depressing output in the early part of its term in office, in order to force down the expected rate of inflation, an

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