Political Regimes and the Cost of Disinflation

Abstract

This study investigates, using data from 1960 to 1998, whether the nature of political regimes can help explain cross-national and intertemporal variations in the cost of disinflationary policies, as measured by the sacrifice ratio. We show that, "ceteris paribus", right-wing governments have lower costs of disinflations than left-wing governments. We argue this is due to a superior credibility, resulting from their stronger anti-inflation reputations. In addition (and in marked contrast to previous studies), we find that when we control for political regimes, trade openness, and other standard factors in this literature, central bank independence has no significant effect on the sacrifice ratio. Copyright (c) 2008 The Ohio State University.

Government Ideology, Democracy and the Sacrifice Ratio: Evidence from Latin American and Caribbean Disinflations

“…This is a unique contribution to this literature that differs from the political economy model of Caporale and Caporale [5]. Unlike the developed OECD nations studied in most of the previous work on the sacrifice ratio, the regime types in our sample were rarely uniformly democratic.…”

“…2 The empirical literature on the sacrifice ratio also tests for the importance of trade openness. Romer's [11] influential paper suggests that disinflations Building on the work of Caporale and Caporale [5] we also investigate the importance of political factors in influencing the cost of disinflation. The significance of changes in political regimes in influencing macroeconomic outcomes been studied using rational partisan models (e.g.…”

“…We also, following Ball [1], Temple [3], and Caporale & Caporale [5], include the total change (or drop) in inflation in our model. Sargent [9] suggests that the size of the change Our final macroeconomic control variables (also drawn from Ball [1]) are the length (in terms of years) of the disinflations as well as a measure of the speed of disinflation.…”

“…Studies investigating the importance of such factors as trade openness, speed, size and length of disinflations, degrees of central bank independence, incomes policies, and nominal wage contracts on accounting for differences in the output costs of disinflations have been conducted by authors such as Walsh [2], Temple [3] and Daniels, Nourzad and VanHoose [4]. In a recent contribution, Caporale and Caporale [5] test whether the political composition of governments can explain differences in the costs of disinflations and find, for a sample of OECD economies, that governments from the political right face lower sacrifice ratios. They argue that this is due to such governments' stronger anti-inflation reputations, which renders disinflation policies undertaken during their tenure more credible.…”

“…Since disinflationary periods are initiated by restrictive monetary (and often fiscal) policies, *Address correspondence to this author at the Department of Economics & Finance, University of Dayton, 300 College Park Dayton, OH 45469, USA; Tel: 9372292403; Fax: 9372292477; E-mail: caporale@udayton.edu their costs depend on how quickly the inflationary expectations of price and wage setters adjust to those policies as well as agent forecasts of the credibility of such policy changes. Although Caporale and Caporale [5] classified government types using a binary right-left designation, LAC nations allow for a richer amount of variation in the designation of political regime type since many of the disinflations were conducted by (both leftwing and rightwing) non-democratic forms of government.…”