DP10838 | Politically Induced Regulatory Risk and Independent Regulatory Agencies


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Uncertainty in election outcomes generates politically induced regulatory risk. Political parties' risk attitudes towards such risk depend on a fluctuation effect that hurts both parties and an output--expansion effect that benefits at least one party. Notwithstanding the parties' risk attitudes, political parties have incentives to negotiate away all regulatory risk by pre-electoral bargaining. Efficient pre-electoral bargaining outcomes fully eliminate politically induced regulatory risk. Political parties can implement such outcomes by institutionalizing politically independent regulatory agencies and endowing them with a specific objective.