A Behavioral Political Economy Approach to the Determination of Economic Policy

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Using the behavioral political economy approach that explicitly considers the systematic irrationality of voters, I analyze the endogenous determination of economic policies. First, I show that the interaction between regulatory policy and the moral hazard problem of regulated agents may generate a perpetual rise and fall of regulatory intensity if voters emotionally want to punish the regulated agents as the source of the problem. Second, introducing a new concept of "trust in the market mechanism" into the analysis, I show that a malfunctioning mechanism can generate a self-reinforcing vicious cycle because a malfunctioning mechanism may lead to the loss of trust in the mechanism but the loss of trust may in turn promote the adoption of anti-market policies. These results provide potential answers to the questions of why policies adopted to tackle the same economic problem vastly differ across countries and why dysfunctional policies continue to be adopted over a long period of time.