ECONOMIC POLICY, MODEL UNCERTAINTY AND ELECTIONS

We analyse a game theoretical model in which policy makers have superior knowledge about the working of the economy relative to voters. We show that parties increase their chances of reelection by basing their policies on the model that best fits in with their preferences. Moreover, we show that if parties care much about holding oce, they may deliberately base their policies on a model that is electorally attractive, even if this model does not describe the working of the economy correctly. Our paper provides an explanation for the observation that dierent political parties subscribe to dierent economic philosophies. Economists disagree. On almost every topic they produce a wide variety of models and they are rarely, if ever, able to show the superiority of one of them. Disagreement on the correct model of the economy may have important implications for economic policy. Frankel and Rockett (1988), for example, demonstrate that international policy coordination may be sub-optimal when governments in dierent countries have dierent perceptions of how the economy works (see also Ghosh and Masson, 1991 and Holtham and Hughes Hallett, 1992). In recent years, the concept of model uncertainty has mainly been used in the international cooperation literature. However, within countries, discussions among policy makers about macro economic policy also tend to revolve around how the economy works (Schultze, 1989). Several authors have noted that dierent political parties subscribe to dierent economic philosophies. Tobin (1972), for instance, contends that in the early seventies conservatives were ofte