Partisan Cycles and the Consumption Volatility Puzzle

Marina Azzimonti, Matthew Talbert
2011 Social Science Research Network  
Standard real business cycle theory predicts consumption should be smoother than output, as observed in developed countries. In this paper we provide a novel explanation of the consumption volatility puzzle based on political frictions. We develop a dynamic stochastic political economy model where parties that disagree on the size of government (right-wing and left-wing) alternate in power and face aggregate uncertainty. While productivity shocks only affect consumption through responses to
more » ... gh responses to output, political shocks (switches in political ideology) change the composition between private and public consumption for a given output size via changes in the level of taxes. As emerging economies are characterized by less stable governments and more polarized societies the effects of political shocks are more pronounced. For a reasonable set of parameters we confirm the empirical relationship between political polarization and the ratio of consumption volatility to output volatility across countries.
doi:10.2139/ssrn.1866431 fatcat:dqp32rca4zasfa3pmg3ia444ua