THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 432

400

PA R T V

FYI

Central Banking and the Conduct of Monetary Policy

Economics and Politics

Recent politico-institutional approaches to
the theory of economic policy emphasize
the incentives of rational and maximizing
policymakers in explaining movements in
macroeconomic variables. Central to this
perspective is the general assumption that
policymakers respond to incentives and constraints just like the rest of the economic
agents. As a consequence, the actual policies
of government give rise to political cycles,
which on the basis of the primary motivational force involved are distinguished into
opportunistic and partisan cycles.
In opportunistic (or electoral) business
cycle models, politicians maximize their popularity or their probability of re-election by
following pre-election expansionary fiscal
policies in order to please the fiscally knowledgeable voters. As a consequence, their
actual policies give rise to electoral business cycles, that is, persistent cyclical patterns of key policy and target variables across
electoral terms, regardless of the political orientation of the incumbent government. In
particular, models of opportunistic cycles

predict pre-election high growth and low
unemployment, increasing inflation around

the election time, and a post-election contraction, regardless of the political party in
power.
In the more accepted partisan cycle models, politicians are ideological; that is, they
represent the interests of different pressure
groups and, when in office, follow policies
which are favourable to their supporting
groups. For example, the left-wing parties
pursue expansionary policies in order to
reduce unemployment, while the right-wing
parties tend to induce post-election contractions in economic performance in order to
reduce inflation. The outcome, therefore, is
partisan business cycles, that is, systematic
and permanent differences in macroeconomic outcomes that differ by political party.
Work by Apostolos Serletis and Panos
Afxentiou of the University of Calgary indicates that there is no credible evidence that
such a political business cycle exists in
Canada.*

* Apostolos Serletis and Panos C. Afxentiou, Electoral and Partisan Cycle Regularities in Canada, Canadian Journal
of Economics 31 (1998): 28 46.

Indeed, some politicians may prefer to have an independent Bank of Canada,
which can be used as a public scapegoat to take some of the heat off their backs.
It is possible that a politician who in private opposes an inflationary monetary policy will be forced to support such a policy in public for fear of not being re-elected.
An independent Bank of Canada can pursue policies that are politically unpopular yet in the public interest.

The Case
Against
Independence

Proponents of a Bank of Canada under the control of the government argue that it is
undemocratic to have monetary policy (which affects almost everyone in the economy) controlled by an elite group responsible to no one. The current lack of de facto
accountability of the Bank of Canada has serious consequences: if the Bank performs
badly, there is no provision for replacing members (as there is with politicians). True,
the Bank of Canada needs to pursue long-run objectives, but elected government officials vote on long-run issues also (foreign policy, for example). If we push the argu-