DO GOOD OR DO WELL? PUBLIC DEBT MANAGEMENT IN A TWO-PARTY ECONOMY*

Authors


  • *

    This paper is a substantially revised version of Chapter II of my Harvard Ph.D dissertation. A previous version was circulated as CEP Discussion Paper no. 53 (1991). I am greatly indebted to my advisors Alberto Alesina and Maurice Obstfeld for their guidance, encouragement, insights and extensive comments on previous drafts of this paper. I would also like to thank John Fernald, Enrico Spolaore, Larry Summers, Phill Swagel, Philippe Weil, two anonymous referees and seminar participants at Harvard, Columbia, INSEAD and the London School of Economics for their comments. The views expressed do not necessarily reflect those of the International Monetary Fund.

Abstract

Governments facing elections may strategically manipulate policy instruments in order to increase their re-election chances. The incentives for strategic manipulation are studied in the context of a debt management model, in which two parties with different inflation aversion compete in elections. It is shown that the inflation-averse party may issue nominal debt in order to make its opponent “look bad” to voters, thus getting closer to the median voter. Nominal debt artificially enlarges the ex-post inflation tax base, causing higher inflation. Conversely, an inflation-prone government may issue indexed debt in order to reduce inflation incentives.

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