Chapter 2. Opportunistic Models of the Political Business Cycle.
Chapter 3. Partisan Models of the Business Cycle.
Chapter 4. Political Cycles in the United States:
Evidence from Macroeconomic Policies and Outcomes.
Chapter 5. Electoral Probabilities and Their Impact on United States: Macroeconomic
Cycles and Asset Prices
Chapter 6. Political Cycles in Industrial Democracies.
Chapter 7. Political Cycles and Macroeconomic Policies (Monetary and Fiscal):
Evidence from Industrial Democracies.
Chapter 8. Political Cycles, Institutions and Monetary Policies.
Chapter 9. Political Parties, Institutions and Budget Deficits
Chapter 10. Conclusions: Summary of Results and Normative
Implications for Monetary and Fiscal Policy.
This book investigates the relationship between political
cycles and economic cycles, namely how the timing of elections, the ideological
orientation of governments and the nature of competition amongst political
parties influence unemployment, economic growth, inflation, and various
monetary and fiscal policy instruments.The topic of "Political Cycles"
is one of the most widely studied subjects in political economics. Many
believe that one can summarize this area of research with the idea that
politicians artificially create unusually favorable economic conditions
before an election, and that voters reward incumbent governments for doing
so, even though the economy will take a turn for the worse immediately
after the election. We argue, instead, that there is much more than this
story to be told: in fact, this book illustrates a complex pattern of relationships
between macroeconomic policies, timing of elections, ideological orientation
of different governments, type of party structure, electoral laws, and
degrees of Central Banks' political independence.
The literature on political and economic cycles developed
in two clearly distinct phases. The first one, which flourished in the
mid-Seventies, uses traditional macroeconomic models, in which, taking
advantage of an exploitable Phillips curve, governments can systematically
and predictably influence macroeconomic outcomes. A strand of this literature
(Nordhaus (1975), Lindbeck (1976)) emphasizes the "opportunistic" motivation
of policy-makers; politicians are viewed as individuals with no policy
preferences of their own, so that they choose the policies which maximize
their chances of electoral victory. The second strand of the literature
(Hibbs (1977)) emphasized, instead, the partisan motivation of policy-makers.
Specifically, according to this view, left-wing parties are relatively
more concerned with unemployment than with inflation, while right-wing
parties have opposite concerns. Moreover, parties stick to their electoral
platform when in office.
The second phase of the literature took off in the mid-Eighties
as a branch of the game-theoretic approach to macroeconomic policy, an
approach pioneered by Kydland and Prescott (1977) and Barro and Gordon
(1983a). These models of political cycles incorporate Rational Expectations
and emphasize the limits that a rational public places upon the extent
to which policy-makers can influence the economic cycle. Cukierman and
Meltzer (1986), Rogoff and Sibert (1988), Rogoff (1990) and Persson and
Tabellini (1990) develop "opportunistic" models with rational expectations.
Alesina (1987) suggests a "partisan" model with rational expectations.
Table 1 frames the above mentioned contributions in a simple
two-by-two matrix. Two critical points differentiate these models. First,
partisan models focus upon differences in policies and outcomes as a result
of the ideological orientation of different governments. On the contrary,
opportunistic models claim that every government behaves in the same way:
opportunistically, in order to win reelection. Second, Rational Expectations
models emphasize the limits in the policy-makers' ability of influencing,
permanently and predictably, the state of the economy. The "rationality
constraint" affects both the policy (via voting behavior) and the economy
(via the expectations augmented Phillips curve).
Our first goal (which we achieve in the next two chapters)
is to illustrate these four types of models. (Box 1 succinctly summarizes
the empirical bearings of these models.) We then test them on data drawn
from the United States and almost all the other OECD countries. We analyze
both policy outcomes (unemployment, output growth, and inflation),
and policy instruments (monetary and fiscal variables). In addition,
we use evidence from financial markets as well as economic and political
indicators such as pre-electoral polls. Also, we discuss how opportunistic
and partisan motivations interact with various institutional features,
such as government structure (coalition versus single-party governments),
electoral laws, and degree of independence of Central Banks.
This book reaches several conclusions: First, the most recent
theories of political cycles, based upon the paradigms of Rational Choice
and Rational Expectations, are empirically more successful than their predecessors.
Second, the partisan model outperforms the opportunistic
one as an explanation of macroeconomic fluctuations in output growth, inflation,
and unemployment. Opportunistic effects are confined to short-run, occasional
manipulations of policy instruments around elections; for instance, in
election years, one might expect "loose" monetary and fiscal policies,
but not a significant surge in output growth or sharp reductions in unemployment.
Third, the lack of a systematic surge of growth in election
years does not imply that economic conditions are not an important determinant
of election results. We argue, in fact, that these two observations are
Fourth, the characteristics of the political cycle depend
upon the nature of the party system. A clear partisan cycle emerges in
"two-party" or "two-bloc" systems. Countries with these party systems typically
have majoritarian, or at least, not strictly proportional electoral laws.
In contrast, partisan cycles are less clearly identifiable in systems with
coalition governments, the typical product of proportional electoral systems.
On the other hand, proportional electoral systems which produce coalition
governments tend to be associated with excessive deficits and deadlocks
Fifth, we discuss how the benefits of independent monetary
institutions are enhanced by the explicit considerations of opportunistic
and partisan behavior of elected politicians.
These results point toward a consistent and rather clear
picture. Our first result establishes the usefulness of the research efforts
of economists and political scientists who have taken seriously the notion
of rationality in political economy. However, even though we emphasize
the role of rational behavior and expectations, we believe that wage and
price rigidities are crucial ingredients for a realistic model of the economy.
The combination of rational expectations and wage-price rigidities leads
to models which exhibit short-run non-neutralities, and medium to long-run
neutrality of aggregate demand policies. In fact, our empirical results
on political cycles are consistent with a view of the economy based upon
sticky wages and prices with rational expectations. Thus, although our
empirical results are primarily concerned with political cycles, they have
broader implications concerning the relative merits of different macroeconomic
Our second set of results highlight the nature of party policies.
We argue that political parties are not all alike in industrial democracies.
Different parties follow distinct macroeconomic policies when in office,
and, therefore, partisan differences have been important determinants of
macroeconomic policies and outcomes in the last thirty years. While the
idea that parties are not all alike may strike many of the non professional
political scientists as obvious, an established tradition in political
science emphasizes the tendency of parties in two-bloc systems to converge
to the middle.
This observation raises several issues relevant to current
events. For example, one may wonder whether partisan cycles will become
less marked in the future. Both left- and right-wing parties may realize,
looking back, that partisan cycles destabilize domestic and world economies.
For instance, in the late Seventies the political barometer of OECD tilted
toward the left: in the United States, Germany, and the United Kingdom,
left-leaning governments pursued expansionary policy, leading to a temporary
boom and a build-up of inflation (aggravated by the second oil shock).
In the early Eighties, the same three major economies moved to the right
of the political spectrum, leading to decisive anti-inflationary policies
and sharp recessions. Of the largest economies, only France followed the
opposite political cycle, turning to the left in May of 1981. The Socialist
government in France in 1982-83 followed typically partisan policies which
were not very successful, partly as a result of the fact that the country
was moving in the opposite direction of the world business cycle. In fact,
the case of France is a good example of an important theme of this book,
namely how external constraints limit the influence of partisan governments
in open, integrated economies.
A related question is whether governments in OECD countries
are learning to be less partisan and follow more "middle of the road" policies
in macroeconomic management. For instance, the policies of the French and
Spanish Socialist governments in the second half of the Eighties point
in this direction. Also the process of European integration will affect
partisan cycles. Will a monetary union and economic integration prevent
national partisan cycles? How will the domestic politics of macroeconomic
policy interact with European level politics?
Our third result highlights an apparent puzzle. The rate
of economic growth is an important determinant of election results, but
incumbent governments do not seem to systematically raise the rate of growth
in election years. We address this puzzle directly by showing how recent
theoretical developments and, particularly, the work by Alesina and Rosenthal
(1995) are consistent with this observation.
Our fourth result, which contrasts two-party systems with
coalition governments, links our book to a recent literature on the impact
of institutional design on macroeconomic policy. Both academics and legislators
around the world are debating the relative merits of proportional versus
majoritarian systems. We believe, and our results confirm, that one faces
a trade-off between these two systems. Proportional systems, which lead
to coalition governments, are likely to insure moderation in policy-making
and reduce the magnitude of partisan cycles. However, coalition governments
are slow in reacting to shocks because each member of the coalition has
a veto power over the choice of policies. In contrast, majoritarian systems
exhibit the opposite features; they do not delay policies, but emphasize
partisan cycles. Theoretical results by Alesina and Drazen (1991) and Spolaore
(1993) and empirical results by Roubini and Sachs (1989a,b), Grilli, Masciandaro
and Tabellini (1991), Alesina and Perotti (1995a) and the findings of this
book support this view. Proportional systems achieve moderation, but create
potentially inefficient delays in policymaking, and fiscal imbalances.
Majoritarian, single-party governments do not delay policy implementation,
but create partisan cycles.
A second institutional variable which we emphasize is the
degree of independence of Central Banks. A vast literature has discussed
the advantage and disadvantage of this institution, and pointed out empirical
regularities and puzzles. Developing the recent work by Alesina and Gatti
(1995) and Waller (1995), we extend the discussion of Central Bank independence
to an explicitly political model, where partisan and opportunistic motivations
of politicians are accounted for. This model resolves several empirical
puzzles, and shows that the benefits of Central Bank independence may be
even larger, when political incentives are explicitly taken into account.
The attentive reader may have noted that in summarizing our
results, we did not make a distinction between those which apply to the
United States and those which hold for other countries. In fact, one of
our most striking results is that the United States are not exceptional.
The same correlations between macroeconomic policies and outcomes on one
side, and elections and government changes on the other, are remarkably
similar in the United States and in other democracies, particularly those
with a two-party system. A widely held view in political science suggests,
instead, that the polity in the United States is unique, and hardly comparable
with that of other parliamentary democracies. On the contrary, we argue
that, at least as far as macroeconomics and politics are concerned, the
similarities between the political economy of the United States and that
of other OECD democracies are much more important than the differences.
In fact, the key differences are not those between the United States and
other parliamentary democracies as a whole, but between two-party systems
and systems of large coalition governments.
1.2 Organization of the Book
This book is organized in ten chapters, including this introduction.
Chapters 2 and 3 illustrate different theories of political cycles. Chapters
4 to 7 discuss empirical evidence from both the United States and other
OECD economies on political cycles. Chapters 8 and 9 cover questions of
institutional design; in particular, the relative performance, in terms
of macroeconomic management, of different party structures generated by
different electoral laws, the role of Central Bank independence and the
issue of fiscal budget rules. The last chapter concludes and summarizes
our results. We now briefly review the content of each chapter so that
the reader has a sense of how the book unfolds.
Chapter 2 covers opportunistic models. We begin with what
we define "traditional" approaches, and, specifically, with the Nordhaus'
(1975) model, the most widely cited in this area. We then move to "rational
opportunistic models", in which voters are rational, rather than naive
as in Nordhaus' model, but are imperfectly informed about some characteristics
of the policy-makers. Because of this information asymmetry, politicians
have incentives to be strategic and opportunistic. These models also rationalize
the widely observed phenomenon of "retrospective voting" (Fiorina (1981)).
That is, they suggest why a rational electorate should evaluate the incumbent
politician by looking at the state of the economy immediately before elections.
This chapter ends with a discussion of the relationship between opportunistic
behavior of politicians and rational opportunistic voting, a point which
is quite important for interpreting the following empirical evidence.
Chapter 3 discusses partisan models. We begin again with
what we refer to as the "traditional" approach by Hibbs (1977) and discuss
party motivations and preferences. Then we proceed to a "rational" version
of the partisan model, originally proposed by Alesina (1987 and 1988b).
This is a model where, rather than a Phillips curve with adaptive expectations,
as in Hibbs, we have rational expectations with wage stickiness. This chapter
also includes an extension of the partisan model to incorporate retrospective
voting behavior. We conclude with a summary of the empirical implications
of all the theoretical models, which we then test in the following three
The empirical chapters begin with a comprehensive study of
the United States, on both macroeconomic policies and outcomes as a function
of the electoral cycle: Chapters 4 and 5 present several tests of political
cycles on United States data from 1947 to 1993. We reach several conclusions
which are then broadly confirmed by our study of all the other OECD countries.
We devote two chapters to the United States not, as we argued above, because
the results for this country are special. The reason is that we can study
this country in more detail than any of the other countries, and we can
compare our results with those of the previous literature on the subject,
which has largely focused on the United States. For instance, Chapter 5
includes several tests using financial market data and pre-electoral polls,
which are not available for other countries.
The next two chapters (6 and 7) consider a sample of almost
all the OECD countries. Chapter 6 tests the implications of all the different
models of political cycles on macroeconomic outcomes, namely, unemployment,
growth, and inflation. We study whether the cyclical movements of these
three variables are systematically affected by the timing of elections
and by the partisan nature of different governments. Our sample includes
quarterly observations on inflation, unemployment, and output growth in
the last three decades for the following 18 OECD democracies: Australia,
Austria, Belgium, Canada, Denmark, Finland, France, Germany, Japan, Ireland,
Italy, the Netherlands, New Zealand Norway, Sweden, Switzerland, the United
Kingdom, and the United States.
While the previous chapter considered evidence of political
cycles by studying economic outcomes, Chapter 7 follows a similar empirical
methodology to test for the presence of political cycles in policy instruments.
We conduct a detailed analysis of opportunistic and partisan cycles in
monetary and fiscal policy.
Chapters 8 and 9 explore the interaction of various institutional
features with party competition and economic policy making. In Chapter
8, we study the role of Central Bank independence. Then we develop, in
more detail, an idea which emerged in previous chapters, namely, that macroeconomic
policies are systematically different in countries with a two-party system
relative to countries with coalition governments. In particular, we document
the trade-off between coalition governments and single-party governments
discussed above. In Chapter 9, we discuss how the evidence on political
biases in fiscal policy affects the debate on the desirability of fiscal
budget rules (such as a balanced budget amendment or a Maastricht type
of fiscal rule).
The last chapter concludes by summarizing our main results
and by discussing whether we should expect to see in the future more political
cycles. In particular, we speculate on how certain institutional developments,
European integration, increasing capital mobility and financial integration,
learning from past experience, and ideological changes in attitude toward
economic policy are likely to reduce or increase the magnitude of partisan
and/or opportunistic cycles in the next decade.
1.3 How does this Book Relate to Previous Research?
This book is the result of several years of research, partly
joint efforts and partly individual efforts of the three authors. Some
of this research appeared in academic journals in the last decade, but
this book is very far from a collection of previously published articles.
First of all, the theoretical part of the book provides a comprehensive
treatment of the theory of political cycles which is unavailable, as a
whole, in any previously published work. Second, all of the empirical results
previously published have been updated to the most recent available data.
This procedure not only checks on the robustness of our previous results,
but also allows us to study whether in recent years some systematic changes
in governments' behavior have occurred. Third, we present several new tests
never previously published. Fourth, and foremost, this book provides a
comprehensive treatment of this area of research; a goal which escapes
any individual paper.
In recent years, several authors have published books on
related topics to the present volume. In terms of coverage, the closest
work to our own is probably Lewis-Beck (1988). Our book differs from his
in two significant ways. First, Lewis-Beck (1988) focuses more on the effects
of economic conditions on voting behavior, rather than on the impact of
elections on the economy, which is, instead, the main argument of our book.
Second, at the time during which Lewis-Beck's volume was written, the new
wave of rational expectation models had not appeared. Thus, his book deals
only with the "traditional" models. In comparison, a critical point of
the present volume is to show the usefulness of these more recent rational
models, as a guide to empirical research.
Alesina and Rosenthal (1995) present an original model of
the political economy of the United States. Even though one of the authors
of the present book is very sympathetic to the message of Alesina and Rosenthal
, the purpose, coverage, and goal of the two books are very different.
First, Alesina and Rosenthal (1995) focus exclusively on the United States.
Second, their goal is not to test a broad range of models, which is our
purpose here. They develop and test a specific politico-economic model
with particular reference to American institutions, and to the issue of
divided government. Third, in this book we consider a much broader range
of economic variables, while Alesina and Rosenthal (1995) focus almost
exclusively on output growth.
Persson and Tabellini (1990) also discuss political-economic
models in the context of their review of recent developments in macro-political-economy.
However, they do not have any discussion of empirical evidence, while one
of the main purposes of this book is to empirically evaluate different
Keech (1995) critically evaluates recent developments in
the field of macro-political-economy from the point of view of a political
scientist. His book is quite different from ours for many reasons. First,
he mainly focuses on the United States. Second, he addresses more normative
issues than we do. Third, his book has much less formal modeling than we
have in ours.
Tufte (1978) and Hibbs (1987a) discuss empirical evidence
drawn almost exclusively on the United States concerning the opportunistic
(Tufte) or the partisan (Hibbs) model. Both books, particularly the one
by Hibbs, are richer in institutional details than ours. However, we draw
evidence on a much larger sample of countries, and we use more economic
variables. In addition, neither Tufte nor Hibbs discusses rational models,
which, instead, are at the center of our attention.
1.4 Technical Level of this Book
We have tried to write a book which is at the same time rigorous
and accessible to a much wider audience than the typical readership of
academic journals. Our goal is to reach not only professional economists
and political scientists, but also the educated general reader with an
interest in this field.
In order to achieve this goal, in the theoretical part of
the book, we will first develop the various models intuitively, with very
little use of mathematical tools. We believe that the basic assumptions
and results of these models can be easily illustrated in this way. Then,
we develop a more formal treatment of the models. These sections (and/or
appendices) can be skipped by the less technically inclined reader. The
empirical part of the book makes use of econometric techniques, which,
for the most part, are fairly standard. A deep and detailed understanding
of technical aspects is never essential to grasp the basic message that
we want to convey.
Models with an exploitable
Rogoff and Sibert (1988)
Persson and Tabellini (1990)
Empirical Implications of Different Models of Political Cycles
i) Opportunistic traditional models
-expansion in the year or two before the elections; GNP growth
above normal, unemployment below normal in the election year;
-inflation begins to increase immediately before or immediately
after the election;
-recession (or downturn) after the election, with gradual
reduction of inflation;
- no differences in policies and outcomes between different
-incumbents reappointed when growth is high and unemployment
low in election years.
ii) Rational opportunistic models
-short run manipulations of policy instruments immediately
before elections: increase in deficits, inflation, money growth in the
two-three quarters before each election;
-tightening of monetary and fiscal policies after elections;
-no systematic, multi-years effects on growth and unemployment
except for, possibly, some minor effects immediately before the election;
-incumbents reappointed when growth is high and unemployment
low in election years.
iii) Traditional partisan model
-unemployment permanently lower, growth and inflation permanently
higher during the tenure in office of left-wing governments than with right-wing
iv) Rational partisan model
-short-run partisan effects after elections: unemployment
temporarily lower than normal and growth temporarily higher than normal
for about two years after an electoral victory of the left; the opposite
outcome after an electoral victory of the right;
-inflation permanently higher when the left is in office
relative to when the right is in office.