Mandatory Spending, Political Polarization, and Macroeconomic Volatility

Grechyna, Daryna (2017): Mandatory Spending, Political Polarization, and Macroeconomic Volatility.

Abstract

Political polarization combined with political turnover have been shown to amplify economic fluctuations (Azzimonti and Talbert, 2014). This paper analyzes a fiscal policy institution capable of reducing the volatility caused by these political frictions. We introduce the distinction between mandatory and discretionary public spending in a political model of optimal fiscal policy. We show that different legislative nature of these components of government spending leads to a divergent impact of mandatory and discretionary spending on politically-driven macroeconomic volatility. Increasing the fraction of mandatory spending in total government spending reduces the volatility; increasing the fraction of discretionary spending has the opposite effect. The presence of the legislative requirements behind the changes in mandatory public spending can explain simultaneous rise in political polarization and decline in the U.S output volatility after the 1980s.

• Item Type: MPRA Paper
• Language: English
• Keywords: business cycles; optimal fiscal policy; mandatory and discretionary public spending; macroeconomic volatility; political economy; political polarization.
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; H - Public Economics > H1 - Structure and Scope of Government > H11 - Structure, Scope, and Performance of Government; H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents > H30 - General; H - Public Economics > H4 - Publicly Provided Goods > H40 - General

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