Policy-Making: Disentangling Politics from Economics

Abstract: This paper models policy-making as an intricate process in which governments balance political and economic considerations. I incorporate this view into a macro model with heterogeneous agents who face idiosyncratic shocks and express their political sentiments. I provide analytical results when political sentiments are uniformly distributed and independent over time. The model endogenously sorts people into three categories depending on their policy demands: the “indifferent”, “the sensible”, and “the senseless” citizens. Policy-making responds mainly to the dynamics of sensible agents, but the survival of the government can be threatened by senseless agents. I expand the model to consider a general distribution of sentiments that depends on past sentiments so that the government takes into account the future threats of its current policy decisions. The model allows for a structural empirical approach to disentangle how economic versus political grounds have influenced policy decisions and the process of development across countries.