There seems to be some evidence supporting the idea of a pol

There seems to be some evidence supporting the idea of a political business cycle. That is, the economy tends to experience particularly fast growth just prior to elections and slower growth or recessions some time after elections.

A. Explain why and how this happens. That is, what is the underlying motivation of those responsible for this effect and what actions (fiscal and/or monetary) do they take to achieve it? (4 points)

B. Use the AD/AS model and the Phillips curve model to explain what effect the actions taken in part A will have on inflation if the economy starts from full employment. (4 points)

C. Now, it may be that the position of the Phillips curve depends on people\'s expectations. If people have adaptive expectations and elected officials act in a way that is consistent with a political business cycle, how is the Phillips curve likely to shift? (4 points)

D. In light of this, offer an explanation for the (actual) observation that countries with central banks that are very independent of elected officials tend to have lower inflation than do countries with central banks very closely tied to elected officials. Hint: Think about the ability of the central bank to carry out appropriate policy. (4 points)

Solution

Political Business Cycles

A)

We know that political business cycle means that the role of political parties in influancing unemployment and inflation trade off in the economic system. The political parties that are ruled in the government then before elections they are improve the economy. At the time of elections the ruling party will stabilize unemployment and inflation. It was done becuase they want to recelect and again to get power. When they achieve the targeted level of inflation and unemployment that will lead to get more votes from the next elections. So they create any policy in the economic system just before the elections.

Some voters in the society look at the policy initiated by the ruling party. It is better than before then they again elected the ruling party. This was the reason for higher growth in the election time.

B)

At the time of election the ruling party is created stagnant employment and also created desired rate of inflation. The Monetory expansion will inprove the level of inflation. When the ruling party expected inflation that to reduced the desired level of inflation in the economy. Then the party will take rational decision in the sitution and also use all the available information in to considerations. Then good policy of the ruling party the Philips curve is shifted to right.

C)

We know that the philips curve represented the trade off beween inflation and unemployment. We know that the ruling party will exploit the short run philips curve. They are creating disinflation in the society. They can used the expansionary monetory and fiscal policy. Here we see that the steeper short run philops curve the ability of the government will reduce their ability.

D)

The important criticism is that in the case of political business cycle the role of central bank not get much independence. The monetory policy is not effctive and cenral bank policies are much sound. The central bank\'s policy is influanced the political dominance. So the central bank policy is not much sound. So the policy of the bank was the desire of the politicians. the monetory policy is passive than the active in the election time.