Political Business Cycles: A Reexamination
Kailash Khandke, Furman University
Objectives:
In modern democracies, elections are national events that bring political affairs into sharp focus. The process of voting and the participation of the electorate can play a central role in the political development of the nation. It is of little surprise therefore, that the nexus between elections, politics and the economy is an extremely well researched area. The political business cycle (PBC) theory argues that politicians, or more particularly incumbent governments manipulate economic policy instruments in an attempt to aid their re-election effort. There have been a number of studies that empirically investigate the existence or lack thereof of such political cycles. The evidence from the literature is mixed at best. In the United States for example there is mixed evidence of the existence of a PBC. Researchers point out that ideology plays a large role in American politics and could undermine the existence of a true PBC. Further the development in macroeconomics of Real Business Cycle (RBC) models cast doubt on the role of incumbent governments in causing and explaining cycles and movements in economic activity. This paper argues that the PBC literature remains an extremely useful and valid framework to study the interplay between governments, economic policy and voters. The reason for this is quite straightforward. There is something quite appealing and intuitive in explaining political cycles through endogenous means rather than exogenous shocks (the real business cycles approach).
Background:
The earliest contributions to the PBC literature can be traced back to Kalecki (Political Aspects of Full Employment, Political Quarterly, 1943) and Downs (An Economic Theory of Democracy, 1957). The definitive and seminal empirical study on the existence of a PBC in the U.S. is by Nordhaus (The Political Business Cycle, Review of Economic Studies, 1975). Since the Nordhaus publication, a number of empirical studies including McCallum (The Political Business Cycle: An Empirical Test, Southern Economic Journal, 1978) and Golden and Poterba (The Price of Popularity: The PBC Reexamined, American Journal of Political Science, 1980) have rejected the PBC hypothesis. This led to alternative formulations of the PBC hypothesis including the Partisan Business Cycle approach. The partisan model of Hibbs (Political Parties and Macroeconomic Policy, American Political Science Review, 1977) argues that politicians are partisan and thus we can expect left of center parties to engineer policies to lower unemployment just before a national election. On the other hand, right of center parties are more likely to aim for lower inflation.
There are a few studies that have attempted to test the implications of PBC in countries outside of the U.S. Alesina and Roubini (Political Cycles in OECD Economies, Review of Economic Studies, 1992) make a useful contribution in this regard. Most of the above studies assume that the timing of the election is fixed. Studies by Ito and Park (Political Business Cycles in the Parliamentary System, Economic Letters, 1988) suggest that in parliamentary democracies incumbents could well take advantage of the fact that the timing of the election is endogenous. Thus the state of the economy drives the election as opposed to the macroeconomy being driven by elections as was previously assumed in the PBC literature. Under the former case we could well have evidence in support of the PBC hypothesis. A recent contribution in this regard is the work of Heckelman and Berument (1998), where they uncover support for elections being a function of monetary and inflation factors in the U.K and Japan (see Political Business Cycles and Endogenous Elections, Southern Economic Journal, 1998).
Expected Results and Discussion:
Despite the large number of studies on economic conditions, electoral timings, ideology and party affiliations, the economics profession has not quite accepted the PBC hypothesis as a sufficient explanation of economic fluctuations. The debate over the causes of macroeconomic fluctuations thus continues. The purpose of this paper in part is to carefully examine the empirical models in the literature in an attempt to uncover the underlying causes for this ongoing debate. Here the paper argues that economists and political scientists alike have not given sufficient credit to studies that look at the theoretical underpinnings of the timing of elections and their link to real economic activity. Further, the paper argues that recent shifts away from explanations of economic fluctuations attributed to PBC, versus explanations of economic fluctuations explained as multiple equilibria in a long-run market economy, are premature. Finally, the paper makes the case that recent studies proclaiming the demise of the PBC have not adequately outlined new econometric techniques that are being increasingly used to examine the true underlying nature of electoral cycles. A reexamination as outlined in this paper could provide future researchers in the area the basis for selecting appropriate techniques for proposed country studies in the PBC context.
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