Essays on political economy and macroeconomics

This dissertation addresses the relationship between political and macroeconomic variables providing evidence of the existence of political opportunism behind macroeconomic policies and that the political environment affects the determination of important economic variables such as inflation. Chapter 1 surveys the literature underlining the contribution to the profession made by the following two chapters of the dissertation. Chapter 2 examines the relationship between the choice of anchor to stabilize inflation and the election cycle. In particular, it shows that in response to the high and chronic inflation that has plagued the developing world since the 1980's, countries adopted different stabilization policies. However, to what extent these stabilization programs were designed for political rather than economic motivations is not clear. Nor is it known whether and to what degree policy-makers may take advantage of the consumption cycles derived from the different stabilization strategies in order to further their political career. Since in chronic inflation countries, exchange-rate-based stabilizations create an initial consumption boom followed by a contraction whereas money-based stabilizations generate a consumption bust followed by a recovery, policymakers may take into account the timing of elections when determining the nominal anchor for stabilization. This paper finds strong evidence that the choice of nominal anchor to stabilize inflation depends on the election cycle. In particular, exchange-rate-based stabilizations are on average launched before elections while money-based stabilizations are set after them, implying the existence of political opportunism in the choice of stabilization anchor. The empirical estimates are obtained through the use of fairly simple econometric models based on a sample of 34 fully-fledged stabilization episodes in 11 countries with high and chronic inflation. The results are robust to different model specifications. This chapter contributes to understanding of interaction between political and economic phenomena providing a useful methodology to quantify this relationship.; Chapter 3 investigates the relationship between inflation and political instability. It is commonly accepted among economists that high and volatile inflation rates generate inefficiency costs to the economy reducing society's welfare. Furthermore, several studies have shown that inflation is harmful to economic growth. It is also widely established that the political environment greatly affects the determination of important economic variables. However, determining the causes of the worldwide diversity of inflationary experiences is an important challenge not yet satisfactorily confronted by the profession. Based on a broad dataset covering over 100 countries for the period 1975–1997 and using standard dynamic panel data econometric techniques, this paper shows that a higher degree of political instability is associated with both higher inflation levels and volatility. Not only does this paper advance the political economy literature establishing a relationship between inflation moments and political instability, but it also has important policy implications regarding the optimal design of inflation stabilization programs and of the institutions favorable to price stability.