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Political business cycles occur when political motivations induce politicians to take actions that cause macroeconomic fluctuations. Cycles may be opportunistic, as when pre-election stimulus enhances incumbents’ reelection prospects, or partisan, as when incoming parties reverse the policies of predecessors.

Opportunistic Models

Models of opportunistic political business cycles appeared in the 1970s. William Nordhaus (1975) argued that incumbent politicians manipulate the economy to enhance reelection prospects. Specifically, expansionary macroeconomic policies are used to stimulate the economy and lower the unemployment rate prior to an election, and myopic voters respond by voting for the incumbent party. Given the model’s expectational Phillips curve, inflationary consequences of the pre-election expansion are largely delayed until after the election, when contractionary policies are used to reduce inflation.

The Nordhaus model generated much interest and research, but ultimately was a victim of the rational expectations revolution. Nordhaus had assumed adaptative expectations. In his model pre-election stimulus produced favorable outcomes only because it was not anticipated. In essence, voters were repeatedly tricked in successive electoral cycles.

In a second phase of the political business cycle literature, models incorporated rational expectations, which rule out systematic expectational errors. Rogoff and Sibert (1988) developed a rational opportunistic model in which asymmetric information replaced voter myopia in explaining electoral cycles in macroeconomic policy variables. Voters have rational expectations but are unsure of the “competence” of politicians. The model can produce an equilibrium in which incumbent politicians increase government spending in preelection periods in an effort to signal competence (ability to produce a higher level of government services with a given revenue). Rogoff (1990) later developed a similar model where the incumbent strategically manipulates the composition of expenditures in pre-electoral years, by favoring items that are more visible to the electorate.

Partisan Models

In partisan models, political business cycles are due to party differences in ideology and economic goals. According to the pioneering work of Douglas Hibbs (1977), left-wing parties are relatively more concerned with unemployment than inflation, while the opposite is true for right-wing parties. These concerns reflect the preferences of the parties’ core constituencies. Consequently, left-wing parties are expected to pursue more expansionary policies when in office. This results in a cycle in which the level of activity and inflation varies with the ideology of the incumbent.

The length of the cycle depends on the way expectations are modeled. Under adaptative expectations, the partisan effect can be long-lasting. But, under rational expectations, cycles are short-lived and depend on electoral surprises. In rational partisan models, business cycles are driven by partisan differences and uncertainty about electoral outcomes. For example, a left-wing policy maker whose election was not fully anticipated can stimulate the economy and reduce unemployment, but this effect will disappear once inflation expectations adjust. Thus, partisan cycles will be temporary, with the strongest impacts occurring after elections.

Empirical Research

The empirical literature on political business cycles is quite extensive. Overall, there is little evidence of systematic opportunistic cycles in economic outcomes, such as unemployment and output, in developed countries. The evidence is stronger for policy instruments, especially fiscal aggregates, which favors models that adopt the rational expectations assumption. Results of tests of the partisan political business cycle for the United Sates and for Organization for Economic Cooperation and Development (OECD) countries also favor rational expectations models, but the effects are somewhat stronger for outcomes than for policy instruments.

The lack of empirical evidence of opportunistic cycles in economic outcomes induced a change in the focus of research toward political budget cycles; that is, cycles in some component of the government budget. Several studies find evidence of political budget cycles in both developed and, especially, in developing countries. According to Brender and Drazen (2005), that finding is driven by the experience of “new democracies,” where voters are inexperienced with electoral politics or lack the information required to detect fiscal manipulations. When only “established democracies” are considered, there is no evidence of political budget cycles. In contrast, Alt and Lassen (2006) show that, conditioning on fiscal transparency, electoral cycles are present also in a sample of nineteen OECD countries, all of which are old democracies. They identify a persistent pattern of political budget cycles in low(er) transparency countries, while no such cycles can be observed in high(er) transparency countries.

Analyzing the effects of political budget cycles on reelection prospects, Brender and Drazen (2008), conclude that election year deficits do not help the incumbent get reelected. Changing the composition of spending or targeting some voters at the expense of others may be more effective ways of increasing reelection prospects.

Bibliography:

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Alesina, Alberto, Nouriel Roubini, and Gerald Cohen. Political Cycles and the Macroeconomy. Cambridge: MIT Press, 1997.
Alt, James, and David Lassen. “Transparency, Political Polarization, and Political Budget Cycles in OECD Countries.” American Journal of Political Science 50 (July 2006): 530–550.
Brender, Adi, and Allan Drazen. “Political Budget Cycles in New versus Established Democracies.” Journal of Monetary Economics 52 (October 2005): 1271–1295.
“How Do Budget Deficits and Economic Growth Affect Reelection Prospects? Evidence from a Large Panel of Countries.” American Economic Review 98 (December 2008): 2203–2220.
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