What Price Accountability? The Lucas Island Model and the Politics of Monetary Policy

Abstract

This paper develops a model of an electoral cycle in inflation and output based on rational inflation expectations and rational retrospective voting. Voters are heterogeneous and partially informed about aggregate macroeconomic variables. They observe precisely how policy stimulates their local economies, but their observations of economic activity in other sectors are imprecise. Voters extract information about the incumbent policymaker's economic competence from cross-sectoral spillover effects. The incumbent has incentives to generate preelection monetary surprises that stimulate the local economies and generate cross-sectoral spillover effects. He thereby creates an impression of economic competence and furthers his reelection prospects. His policy manipulations are the price of political accountability. On a positive note, the incumbent is more likely to survive voter scrutiny if he is more competent than the average political candidate.

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