Political Price Cycles in Regulated Industries: Theory and Evidence
Código: WPE – 062
Rodrigo M. Moita
The political cycle of regulated prices has been documented in several countries and empirically tested by Paiva (1996). The relationship between politics and economic policy has a long tradition in economic analysis. The early work of Stigler (1971) which was further developed by Peltzman (1976) treats the regulatory process as the arbitration of conflicting social, economic, and political interests rather than a pure welfare-maximizing effort. In this model, the regulated price is chosen so as to maximize political support for the incumbent government-regulator. However, the static nature of this theory limits its ability to explain the political cycle. This paper combines the main ideas of Peltzman (1976) with the ones from the political business cycle literature, Rogoff and Sibert (1988) and Rogof (1990), to model the regulator’s problem as a signaling game where politicians set the regulated price trying to maximize electoral support by signaling to voters a pro-consumer behavior. Political incentives and welfare constraints interact in the model yielding an equilibrium in which the real price in a regulated industry falls in periods immediately preceding an election. Besides presenting a new model of political price cycles in regulated industries, this paper also provides empirical support for this theory. Using quarterly data from 32 industrial and developing countries over the period 1978-2004, we find strong statistical and econometric evidence pointing towards the existence of electoral price cycles in gasoline markets.