Endogenous
Stabilization in Open Democracies
In the new Keynesian theory of endogenous stabilization governments
react quickly to lean against the macroeconomic wind. In open economies
policymaking is complicated by concern about the trade balance. We extend the
political business cycle model by assuming that governments have objectives
with respect to macroeconomic performance relating to three indicators (growth,
inflation and net exports), but are constrained by an augmented Phillips curve
and the inverse relation between net exports and domestic output. As long as
adaptive expectations replace rational ones, econometric tests support this
characterization of the political-economic equilibrium, and suggest how it is
conditioned by political ideology and central bank independence.