Political forecast cycles

A moral hazard model is used to show why overly optimistic revenue forecasts prior to elections can be optimal: Opportunistic governments can increase spending and appear more competent; ex post deficits emerge in election years, thereby producing political forecast cycles – as also found for US states in the empirical literature. Additionally, we obtain three theoretical results which are tested with panel data for Portuguese municipalities. The extent of manipulations is reduced when (i) the winning margin is expected to widen; (ii) the incumbent is not re-running; and/or (iii) the share of informed voters (proxied by education) goes up. •Opportunistic governments use overly optimistic forecasts prior to elections.•Increased spending leads to deficits and political forecast and budget cycles.•We find evidence for Portuguese municipalities (as previously found for US states).•Less manipulation when the incumbent is sure to win or not re-running.•More manipulation when voters are less informed.