In the current energy crisis triggered by the war in Ukraine, Western governments seem to be willing to spend unprecedented amounts of money subsidising socially weaker groups in society. Incurring the necessary deficit seems feasible because the repayment burden is limited; interest rates are still fairly low and repayment of the deficit is not expected to happen in the near future. Political economists are suspicious of the governments' motivations. They believe that, once again, politicians may behave opportunistically to increase their re-election chances. We argue that this may actually not be the case and present a new argument why more opportunistic politicians could actually be better off with a lower budget deficit. The paper combines a moral hazard model of political budget cycles with an empirical analysis based on a panel dataset covering 87 democracies, from 1980 to 2017.

The model assumes that a share of voters suffers from debt illusion and that the incumbent can increase her re-election chances by expanding government spending. However, if the deficit is not very costly, i.e., when interest rates and/or the repayment are low, it is optimal for the incumbent to overspend (on public goods provision); the incumbent’s manipulation exceeds the amount necessary to maximize re-election chances (over-manipulation). Then, more selfish politicians, with higher ego rents and, therefore, increased re-election motivation, no longer increase the manipulation (as in previous PBC models) but reduce the over-manipulation instead.

The empirical analysis follows the theoretical assumptions very closely. The main estimations are based on fixed-effects models using a panel dataset which covers elections held in 87 democracies, from 1980 to 2017. The empirical results support the theoretical model’s prediction, showing that (i) the level of deficit decreases with the repayment obligation and (ii) the benefit of being elected (the ego rent) moderates the effect of the repayment obligation on the deficit, i.e., a higher ego rent reduces the deficit when the repayment obligation is low (and increases the deficit when the repayment obligation is high). These results are robust to using alternative definitions of democracy and alternative proxies of debt illusion, repayment obligation, and ego rent.