Why Are Political Budget Cycles Larger in Monetary Unions?

Independent central banks typically counteract a positive fiscal shock by increasing the interest rate which prevents (or at least reduces) electoral manipulation by the fiscal authority. In the paper presented in this ZEW Research Seminar, the authors argue that this mechanism is less effective in a monetary union because the single central bank must weigh the policies of all its member countries. They find that the ECB actually reacts less to national elections when they take place in only some rather than several member countries. Yet the ECB’s reaction does not stop fiscal authorities from manipulating in any case. These results imply that fiscal manipulation is larger in a monetary union.