Electoral opportunism and fiscal policy before and after the EMU

A Masters Thesis, presented as part of the requirements for the award of a Research Masters Degree in Economics from NOVA – School of Business and Economics

The adoption of a common currency in Europe, under the supervision of an independent European Central Bank, is likely to have had consequences on both the conduct of fiscal policy and the incentives to exploit political business cycles in each country. This work proposes a framework to analyze the in.uence of Central Bank Independence (CBI) on opportunistic political budget cycles before and after Economic and Monetary Union. We first focus on the situation before the EMU and present a model of opportunistic budget cycles in the presence of a central bank with a given level of independence. Secondly, we extend the model to the situation of the EMU to understand whether small countries take advantage of the fact that the one central bank setting monetary policy may under react to their own actions, ofering policy-makers leeway to conduct opportunistic expansionary fiscal policies before elections. In a monetary union with a common central bank and opportunistic policy-makers the trade-of is between the degree of independence of the central bank and its inattentiveness to the smaller economies that are members of the monetary union. We present some empirical evidence that gives some supports to the main findings of the model by analyzing evidence from twelve countries of EMU over the period 1980-2012.