The Challenge of Macroeconomic Stabilization in Fragile States

We develop a dependent-economy model with macroeconomic policies derived from a policymaker maximization problem. The model assumes that the probability of state failure is a function of the economic situation and the government’s capacity to deliver favors through public employment. We solve the model under three different policymakers’ objectives: the “political” policymaker, technocratic policymaker, and social planner. Public employment is higher if it is decided by the political policymaker, but the probability of state failure is higher because fiscal deficits lead to inflation. A technocratic policymaker implements a conservative fiscal plan but the probability of state failure is higher than what could be achieved if this probability was taken into account in the objective function. Comparative statics provide a “test” of the objective function: a benevolent policymaker should take advantage of additional fiscal space to improve the economy, not to spend all resources on policymaker consumption or on public wages.