Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Creating artificial booms: Political business cycles

Policy makers have powerful tools at their disposal: using fiscal and monetary policy they can temporarily create an economic boom where wages are rising, unemployment is falling and so on. Unfortunately, if politicians were to do this, eventually they’d have to reign in the economy using policies that have the opposite effect. (See Chapters 9–11 to understand why this is true).

But what if, before an election, the ruling party decides to create a temporary boom so that when people come to vote, the economy looks rosy. People could easily misinterpret this as a sign of sound economic policy and vote for the current government. Of course after the election is won, the government has to rein in the economy, causing a recession. The incumbent party hopes that the voters have forgotten about this by the time of the next election, especially if another artificial boom is engineered at that time too!

Clearly this behaviour isn’t the hallmark of good economic policy: it creates unnecessary uncertainty for people and gives rise to what economists call political business cycles – in other words, stimulating the economy before an election, only to reign it back in after the election.


Borrowing against future generations

Another way politicians can act strategically if policy is at their discretion is by borrowing too much money. Everyone likes government spending: it means better public services, better infrastructure and more generous benefits. What people are more reticent about is paying for them in the form of taxes.

Is it possible to have large amounts of government spending and low taxes simultaneously? Well, sort of: the government can run a budget deficit and fund it by borrowing. This borrowing has to be repaid at some point, however

– which means higher taxes for future generations. The thing is that only the current generation votes in elections – people who aren’t yet born can’t vote (great idea for a sci-fi movie though)!

The worry is that politicians have incentives to borrow large amounts of money now to provide inflated living standards for today’s electorate at the expense of tomorrow’s electorate. Economists quite rightly are concerned about this because it goes against what they call intergenerational equity – which is the idea that policies should be fair across generations.