The electoral origin of government spending shocks

By Raphaelle G. Coulombe, Queen’s University

The ratio of government expenditure to output fluctuated considerably after WW2. As shown in Figure 1, many countries experienced rapid decreases or increases in the share of central government expenditure in output at different points in time. For example, there were instances of sharp decreases in Canada, Italy, and Denmark since the mid-1990s, while the United States and United Kingdom experienced the opposite trend over that same time period.

Figure 1: Ratio of central government expenditure to output
Figure 1: Ratio of central government expenditure to output

Figure 2 shows that a pattern emerges when examining the change in the ratio of central government expenditure to output during a party’s time in office (in percentage points) against the same party’s ideology on the left-right scale for the twelve OECD countries in the sample since 1945. The color blue denotes right-wing parties (parties with ideological scores greater than zero) while the color red denotes left-wing parties (parties with ideological scores smaller than zero). When in office both right- and left-wing parties tend to turn the ratio of government expenditure to output in their preferred direction. The negative relationship between right-wing parties and the change in the G-to-Y ratio is statistically significant at the 1% level. In addition, while right- (left-) wing parties tend to decrease (increase) the ratio of government expenditure to output, it also seems that the decrease (increase) in the ratio becomes more pronounced the more right- (left-) wing the party is.

RCG Blog Figure 2
Figure 2: Change in G/Y during time in office against party’s ideology

The focus of my recent research is to model and document the origins of the variations in fiscal policy stance both across countries and time and to provide a deeper understanding of government decisions towards spending, which amounted to 38% of GDP on average in advanced economies in 2018 (IMF estimates, 2019). To that end, I relax a common assumption in traditional Keynesian and neoclassical macroeconomic models that government spending is an exogenous process (for example see Woodford 2011 or Baxter and King 1993).

I first develop a theoretical model of the joint determination of economic and electoral outcomes in which government decisions towards spending and taxation vary according to the ideology of the ruling party and the state of the economy. The model introduces heterogeneous parties and voters into a one-sector neoclassical model extended with repeated elections at fixed intervals. The key assumption of this model, which is motivated by the empirical evidence, is that the left-wing party wants a higher share of public consumption in output than the right-wing party. In my framework, the ruling party follows a fiscal rule for expenditure that operates like a ratchet mechanism by gradually turning the government spending-to-output ratio in its preferred direction.

I then exploit the large variations in the domestic political environment across twelve OECD countries in North America and western Europe as well as variations in the business cycle and in the stance of fiscal policy since 1945. To capture key differences in ideology and voting behaviour across countries, I use a rich dataset from the Manifesto Project database that documents electoral outcomes and time-varying ideological party positions estimated from electoral platforms.

The model shows that an important part of the variance in government spending can be linked to the political sector for most countries studied (54% on average). Overall, I find that elections are often a precursor to government spending shocks in countries like the United States and the United Kingdom with high political polarization and persistent government ideology. Intuitively, in these countries, an election that leads to a change in government tend to be followed by larger and more persistent government spending shocks.

Questions remain about why the political sector is more important for the variations in government spending in some countries. For instance, the differences in political polarization and in the persistence in government ideology can ultimately stem from a difference in political systems. In fact, the countries for which most of the variations in government spending is linked to the political environment are countries with a smaller number of dominant parties.

References

[1] Baxter, M. and King, R. (1993). Fiscal policy in general equilibrium. American Economic Review, 83(3):315–334.

[2] Volkens, A., Lehmann, P., Matthieß, T., Merz, N., Regel, S., and Werner, A. (Version 2018a). The manifesto data collection. Manifesto Project (MRG/CMP/MARPOR). 

[3] Woodford, M. (2011). Simple analytics of the government expenditure multiplier. American Economic Journal: Macroeconomics, 3:1–35.

Shutdown policy ignores economic consequences in order to minimize Covid-19 infections at any cost

By Christopher Cotton

Christopher Cotton, Ph.D., is a Professor of Economics at Queen’s University, where he holds the Jarislowsky-Deutsch Chair in Economic & Financial Policy and is the Director for the John Deutsch Institute for the Study of Economic Policy.

Before deciding whether we should start to reopen the economy, we need to understand what it is that we are trying to accomplish through the shutdown. If the shutdown is intended to slow the spread of COVID-19 and prevent our health care system from being overwhelmed, then we have room to start slowly loosening shutdown restrictions today. If, however, our objective is to minimize the number of Canadians that become infected or die from the disease, which seems to be the objective of public health officials today, then the shutdown may need to continue indefinitely.   Read More »

Dear Florida, Can NY borrow some ventilators? The U.S. needs better coordination of medical equipment across states

By Christopher Cotton and Neil Renwick

Christopher Cotton, Ph.D., is a Professor of Economics at Queen’s University where he holds the Jarislowsky-Deutsch Chair of Economic & Financial Policy and is the Director of the John Deutsch Institute for the Study of Economic Policy. Neil Renwick M.D., Ph.D, is a Clinician Scientist and Head of the Laboratory of Translational RNA Biology at Queen’s University and an Associate Attending Physician at The Rockefeller University Hospital in New York City. 

Last week, NY Governor Andrew Cuomo issued a plea to the rest of the country: “Help New York. We’re the ones hit right now… We need relief. We need relief for nurses working 12-hour shifts. We need relief for doctors. Help us now and we will return the favor.”

This request is based on the fact that states like New York, New Jersey, and Michigan are being hit hardest by the COVID-19 pandemic now, and are likely to see their apex in the next week or two, while other states are unlikely to reach their peak until later this spring. Today, as New York faces a shortage of health care workers, there are other places in the U.S. with excess medical capacity, where doctors and nurses not yet being pushed beyond their breaking point.

We claim such an argument not only applies to doctors and nurses but also applies to life-saving ventilators as well.Read More »

We Hit the Brakes. So, What Now?

By Thorsten Koeppl

Thor Koeppl is a Professor of Economics and RBC Fellow at Queen’s University. He also serves as a Scholar and member of the National Council and Monetary Policy Council at the CD Howe Institute. 

Imagine you are driving your car on an alpine road.  You see some rocks starting to fall, a rockslide!  What do you do? Slam on the brakes.  Stop.  You take a deep breath and, after a sigh of relief that you kind of dodged it, you think: So, what’s next? How do I get past that rock slide?

This is where we are at in Canada in our response to the current CoVid-19 pandemic.  We brought the economy pretty much to a full stop.  It is fair to say that this reaction will likely save Canadians being fully engulfed in the rock slide.  We yet do not know how big the benefit will be in terms of lives saved or how large the costs will be on the economic side, but we did the right thing.  Act on the side of caution and hit the brakes.

Soon, hopefully, there comes the time to catch a breath and look forward to see how we can navigate the medium-run fall out from the pandemic.  And this is where economists and the way they tend to think can help us a lot.  After all, economists are “social engineers” that deal with problems where individual behaviour needs to be steered in the right direction to achieve better outcomes for society.Read More »

Border Policies, Exchange Rates, and Canadian Retailers

By Beverly Lapham, Queen’s University

The nominal exchange rate between Canada and the U.S. fluctuates considerably over time. These fluctuations affect Canadian retailers in at least two ways. Firstly, exchange rate movements affect retail price differences between the two countries (see [3]). In response to these price differences, consumers travel across the U.S.-Canada border to purchase goods in the country with lower prices. This is illustrated in the figure below which shows that nominal exchange rates are correlated with cross-border travel by Canadians. Hence, through travel responses, Canadian dollar appreciations tend to decrease demand, revenue, and profits for Canadian retailers. Secondly, because Canadian retailers often use imported inputs, movements in exchange rates may cause fluctuations in retailers’ costs. Thus, Canadian dollar appreciations tend to decrease costs and increase profits of Canadian retailers. My research with co-authors estimates the effect of exchange rate fluctuations on heterogeneous Canadian retailers’ revenues and profits and examines the impact of changes in border policies on those relationships.[1][2]

Read More »

Queen’s Economics and Psychology Departments Jointly Welcome Dr. Anita Tusche

By Eliane Hamel Barker and Ardyn Nordstrom, Queen’s University

tusche_foto_caltech2017Last November, the Economics and Psychology departments at Queen’s University were pleased to welcome Dr. Anita Tusche as assistant professor and Queen’s National Scholar. The Queen’s Economics Department is delighted to be welcoming , and would like to take this opportunity to introduce the Queen’s community to Dr. Tusche’s work. Before joining Queen’s, Dr. Anita Tusche completed her PhD in Psychology in Berlin, Germany and continued with Postdoctoral research at the Max Planck Institute for Human Cognitive and Brain Sciences and then the California Institute of Technology. Most of Dr. Tusche’s research is in the exciting new field of neuroeconomics, which is at the intersection of behavioral economics, psychology, neuroscience and computational modelling. At the core of her research is the aim to understand the mechanisms that drive people’s differences in decision making by using computational models on data collected from computer experiments, eye-movement measurements to determine what people pay attention to, and functional and structural brain data.

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How Flexible is Inflation Targeting in Canada?

By Gregor W. Smith, Queen’s University

The Bank of Canada often describes inflation targeting as flexible. For example, the preamble to its October 2018 Monetary Policy Report says:

“Canada’s inflation-targeting framework is flexible. Typically, the Bank seeks to return inflation to target over a horizon of six to eight quarters. However, the most appropriate horizon for returning inflation to target will vary depending on the nature and persistence of the shocks buffeting the economy.” [3]

The flexibility thus involves a deferral in the planned return of the inflation rate to 2%, the mid-point of the target range. This deferral is applied because policy is being used to respond to some other goal. One can read more about this strategy in speeches by Bank of Canada officials or in the background documents at the last two renewals of the inflation target [1,2].Read More »

Who should be in charge of climate policy?

By Peter Shannon, Queen’s University

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Questions from California’s battle over carbon emissions

Battles over climate change policy between state, provincial, and federal governments have been a common occurrence in 2018. In April, the Environmental Protection Agency started a row with California over emissions standards. Then EPA administrator Scott Pruitt announced that it would repeal automobile emissions standards set by the Obama administration and threatened to waive individual states’ power to set their own emissions standards if California was unwilling to negotiate over its own higher pollution and mileage standards. California’s Attorney General replied that California was prepared to sue the EPA if necessary to maintain its current regulations. [1] California followed through on this promise, filing a lawsuit with 16 other states in May. [2] The disagreement over emissions policy extends far beyond automobile standards: California is the only US state with a complete carbon market, although nine northeastern states have tradable emissions caps that apply only to power producers. Meanwhile, the President Trump withdrew America from the Paris climate accord, scoffed at the notion of federal climate change policy and claimed scientists predicted the polar ice caps “were going to be gone by now, but now they’re setting records.” [3] With the battle over carbon policy becoming one of the most significant issues in Californian politics, it is worth asking whether carbon pricing is a worthwhile policy and if so, which level of government should handle carbon emissions policy.

Read More »

Understanding Fiscal Policy in a Changing Political Environment

By Raphaelle Gauvin-Coulombe, Queen’s University

Fiscal policy in response to the Great Recession of 2008-09 varied widely across OECD countries. The United States, for example, took an expansionary fiscal stance, adopting an important stimulus package in February 2009 on the order $787 billion (CBO estimate). Canada’s response went in the same direction with its Economic Action Plan, a $30 billion stimulus package enacted in January 2009 (Department of Finance, Canada). Alternatively, on the other side of the Atlantic, policy-makers in the United Kingdom, Germany, and elsewhere either proposed, or implemented, austerity measures. The effectiveness of these different responses is still debated among economists and policy-makers today, and the political drivers of such heterogeneity are still imperfectly understood. Read More »

Universal Basic Income: Our Solution to Automation?

By Kyla Fisher, Queen’s University

Over the past few years there has been increasing discussion in the media about the potential that technological change has in leading large portions of society to be unemployed. On one side, doomsayers point to the rapid progress in automation and artificial intelligence (AI) as signs that human workers will soon be replaced. Their opponents note that these same predictions were made in the past during the industrial revolution and turned out to be incorrect. One thing that does seem clear is that large numbers of jobs are susceptible to automation. A study by Carl Benedikt Frey and Michael Osborne found that 47% of U.S. workers had jobs at high risk of future automation (Frey & Osborne, 2017). The remaining question is whether enough new jobs will be created in other industries that can employ the displaced workers. Whatever your opinion, it is interesting to consider our options as a society if we had a major increase in unemployment. To consider this, let us assume that it’s 20 years in the future and that we are facing a significant reduction in the number of jobs available. What are options? In this article, we’ll consider two of the most popular solutions: universal basic income (UBI) and guaranteed basic income (GBI).

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