A mathematical model of the Austrian political business cycle

We construct a formal model that reconciles non-formal risk-based Austrian business cycle theory with models of political business cycles. In our model, the incumbent political party induces the central bank to enact an expansionary monetary policy. This policy lowers the real interest rate, which leads to an increase in investments. As more individuals invest, assets inflate, leading to a boom-bust cycle; voter utility increases because asset values are higher. An increase in voter utility leads to an increased likelihood that the incumbent political party will be reelected. In an attempt to avoid a violent bust in assets, the central bank may implement a contractionary monetary policy to raise the real interest rate in increments. If the financial system becomes illiquid before the policy is implemented, then a speculative bubble burst occurs. The cycle regenerates a year before the next election when an accommodative monetary policy is implemented once again.