Business Cycles, Political

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Business Cycles, Political

Understanding why the economy contracts and expands at regular intervals, commonly called a business cycle, has puzzled economists for centuries. One explanation, dubbed the political business cycle theory, posits that the economy shifts or cycles during presidential election years, or when power is transferred from president to president. Partisan varieties of political business cycle theories associate the political business cycle with the president’s political party. The opportunistic approach argues that the desire to be reelected drives the cycle without reference to political party affiliation.

POLITICAL BUSINESS CYCLE THEORIES

Michal Kalecki in Political Quarterly (1943) pioneered the idea that governments stimulate the economy prior to elections to garner constituency support and capitalists reverse the stimulus after elections. Kalecki hypothesized that capitalists were opposed to interventionist government spending to create full employment. Capitalists would therefore exploit their influence on politicians after elections creating a political business cycle. His idea was extended decades later by William Nordhaus in the Review of Economic Studies (1975). Nordhaus posited that as an election approaches, incumbents reduce unemployment by exploiting the short-run tradeoff between inflation and unemployment described by a Phillips curve. Once elected, the party in power follows a policy of austerity to reduce the inflation that was created earlier by the expansionary policy. The early “opportunistic” models predicted that output growth increases in the year-and-a-half before each election as incumbents stimulate economic growth to improve their chance of reelection. However, if the public is rational then it would be impossible for incumbents to systematically fool the public, and so more advanced models were developed.

In the second wave of these models Ken Rogoff and Anne Sibert, in the Review of Economic Studies (1988), demonstrated that opportunistic cycles can occur when voters are assumed to be rational, as long as individual leaders had private information about their competence; that is, the ability to provide government services at a low cost.

The second class of political business cycle models (termed partisan models) requires differences in policy objectives of political parties to be the impulse for the cycle. Left-wing governments stimulate the economy once elected whereas right-wing governments contract the economy due to ideological differences concerning aversion to higher inflation versus higher unemployment. In the most widely accepted specification adopted by Alberto Alesina in the Quarterly Journal of Economics (1987), only the unanticipated effects of monetary policy differences between the two parties can be a cause of the political business cycle.

These two approaches to understanding political business cycles generate the following important predictions. First, the partisan model predicts that left-wing governments expand while right-wing governments contract early to midway through their terms. Second, according to the opportunistic model, presidents whose parties subsequently hold on to the presidency at the following election (either by reelection or another member of their party winning) will have expanding economies as the election approaches.

EVIDENCE ON POLITICAL BUSINESS CYCLES

Since World War II the real U.S. economy has grown more rapidly after every Democratic president has begun his term and has grown more slowly after every Republican president has begun his term, providing support for the partisan approach. There is less consistent empirical support for the opportunistic approach to the political business cycle.

Although establishing the empirical regularities of output is an important first step for establishing the existence of a political business cycle, the transmission mechanism through prices is less evident in the data. Inflation should be higher under Democratic administrations than under Republican administrations. For the United States, there is little evidence to support this conclusion. As Allan Drazen noted in Political Economy in Macroeconomics (2000), “Democratic administrations have lower average inflation than Republican administrations in the first half of their terms, exactly opposite what the rational partisan theory of inflation surprises predicts” (p. 262).

An alternative theory of the political business cycle, termed the real political business cycle, is found in the Journal of Public Economics, in a 2003 article by S. Brock Blomberg and Gregory Hess. Rather than explain the political business cycle as the natural consequence of shifts in regime between two parties who have different tastes for inflation, Blomberg and Hess model the political business cycle as a dynamic process that responds to both partisan and individual leader characteristics in the size and scope of the government. While the parties themselves differ on the size of government, individual leaders also differ in their abilities to deliver on their promises at the lowest cost. Methodologically, their article blends a partisan and opportunistic explanation for the political business cycle with fiscal policy being the impulse for the cycle.

There appears to be stronger empirical support for the transmission mechanism in the real political business cycle. Both tax revenue and spending reveal a strong partisan influence: there is a sharp increase in spending and taxes for Democrats in the second or third years of the election term, with a symmetric decrease in spending and taxes by Republicans. These fiscal changes coincide with the business cycle movements consistent with a real political business cycle. Still, given the mixed evidence supporting certain aspects of real business cycle models, future research is necessary to explain these same aspects in the real political business cycle.

SEE ALSO Business Cycles, Empirical Literature; Business Cycles, Real; Business Cycles, Theories; Economic Crises