Political and Monetary Institutions and Public Financial Policies in the Industrial Countries

TLDR

Industrialized OECD countries show divergent deficits, debts, and inflation partly because electoral systems and political traditions shape governments’ capacity to manage fiscal challenges. The study examines how specific institutions constrain and incentivize policymakers, shaping fiscal and monetary decisions. The authors find that political factors—especially government durability—drive fiscal outcomes, while central bank independence ensures low inflation without harming real performance, and that monetary and fiscal discipline are largely unrelated, offering insights for indebted or inflationary economies and the EU monetary union.

Abstract

Institutions and policies Vittorio Grilli, Donato Masciandaro and Guido Tabellini Why do countries as similar as the industrialized OECD countries go through such different experience in terms of public deficits and debts or in terms of inflation? The answer cannot come from macroeconomic policy responses to different disturbances, nor from the principles of optimal taxation, but rather from politics. This article focuses on the role that particular institutions exert in providing constraints and incentives which shape the actions of policymakers. The electoral process and political traditions affect the ability of governments to deal with deficits and mounting debts. What seems to matter most, it is found, is the effect of the durability of governments. Governments with short horizons act myopically and never quite tackle the hard choices. Such governments typically exist in countries with an electoral system favouring many small political parties. Central bank independence promotes low inflation with no apparent costs in terms of real economic performance, irrespective of the political institutions. In fact there is no link between monetary and fiscal discipline. These findings carry powerful implications for countries facing high indebtedness or stubborn inflation, but also for the construction of the European Economic and Monetary Union.