Political Business Cycle
Encyclopedia Britannica (reference below) defines the Political business cycle as the “fluctuation of economic activity that results from an external intervention of political actors.”
“The term political business cycle is used mainly to describe the stimulation of the economy just prior to an election in order to improve prospects of the incumbent government getting reelected. Despite numerous attempts to establish their existence, empirical evidence of political business cycles remains rather equivocal.
“Expansionary monetary and fiscal policies have politically popular consequences in the short run, such as falling unemployment, economic growth, and benefits from government spending on public services. However, the same policies, especially if pursued to excess, are found to have unpleasant consequences in the long term, such as accelerating inflation and damaging the foreign trade balance. Thus, they can harm the long-term growth potential of the economy. Thought to be rational actors with short-term horizons of calculation, politicians will pursue popular expansionary monetary and fiscal policies immediately before an election. However, being aware of adverse effects of expansionary policies, they will not intend to keep those measures after they get elected. Thus, after the election is over, politicians will often reverse course, which may include cutting spending, slowing the growth of money supply, and allowing interest rates to rise. As a result, the regular holding of elections will produce cyclical fluctuation of economic activity because of recurring patterns of government stimulus and restraint in order to induce an artificial boom in the election time.
“Politicians’ rational preference of short-term political concerns over macroeconomic calculation in economic policy making can also affect general monetary and fiscal policy. Politicians will try to drive up the natural or equilibrium rate of employment. Thus, the rate of inflation and interest rates will be higher than they need to be.
“Likewise, there is a political cycle found in welfare regimes. Accordingly, the state officials will tend to make the welfare system more generous in the pre-election period and to restore restraint and incentives to work afterward.”
The political business cycle was first formalized in an analytical framework by William Nordhaus in 1975. Eric Dubois (2016, reference below, pdf on right) summarizes the literature that has emerged since Nordhaus published his framework.
“Until this ground-breaking contribution, in most academic works, the government was considered in economic models to be a social planner, maximizing a social welfare function which coincides with the utility function of the representative agent in the economy. …
“In Nordhaus’s (1975) theory, governments are driven by private interest and care only about their reelection prospects. They exploit the short-term Phillips curve and benefit from the naïve expectations of voters to attain their goal. As voters are concerned about unemployment, the incumbent improves the probability of being reelected by increasing the inflation rate so that the unemployment rate decreases just before the election. After the election, the government faces a high inflation rate and then implements austerity measures, leading to more unemployment. Unemployment and inflation are thus subject to cyclical fluctuations linked to the rhythm of elections and these fluctuations are called “political business cycles” (PBCs).
The first trace of PBCs can be found in Åkerman (1947), who showed that between 1830 and 1945 in the United States, short-term economic cycles were linked to the four-year presidential election cycle. But his analysis was exclusively empirical and demonstrated no precise causal mechanism. Ten years later, Downs (1957a,b), although not explicitly dealing with cycles in macroeconomic variables, proposed a hypothesis that would serve as a foundation for Nordhaus’s (1975) paper: politicians are driven by private interest. In Anthony Downs’s (1957b, p. 28) words: “We assume that they act solely in order to attain the income, prestige, and power which come from being in office”. This motivation gives rise to an operational objective for politicians: to maximize the number of votes in their favor and win the election. However, Downs says nothing about the macroeconomic variables the government has to manipulate to reach that goal. He simply states that “by means of economic and other actions, [the government] tries to manipulate both present and future utility pay-offs to voters in a way that will win their votes” (Downs 1957b, p. 176). According to Downs (1957a, p. 137), the government “is an entrepreneur selling policies for votes instead of products for money”. In this view, there is no room for ideology. Politicians treat the possible political choices solely as a means of fulfilling their private objectives, objectives that can only be achieved if they are elected: “parties formulate policies in order to win elections, rather than win elections in order to formulate policies” (Downs 1957b, p. 28).”
Atlas topic, subject, and course
Jan Drahokoupil (2018), Political Business Cycle, Encyclopedia Britannica, at https://www.britannica.com/topic/political-business-cycle, accessed 4 September 2018.
Eric Dubois (2016), Political Business Cycles 40 Years after Nordhaus, Public Choice, Springer Verlag, 2016, 166 (1-2), pp.235-259., at https://hal.archives-ouvertes.fr/hal-01291401/document, accessed 15 December 2018. Citations noted above:
Nordhaus, W. D. (1975). The political business cycle. Review of Economic Studies, 42(2), 169–190.
Akerman, J. (1947). Political economic cycle. Kyklos, 1, 107–117.
Downs, A. (1957a). An economic theory of political action in democracy. Journal of Political Economy, 65(2), 135–150.
Downs, A. (1957b). An economic theory of democracy. New York: Harper & Row.
Page created by: Alec Wreford and Ian Clark, last modified 15 December 2018.
Image: Moody’s Analytics, Mexico’s Political Business Cycle, at https://www.economy.com/dismal/analysis/commentary/294677/Mexicos-Political-Business-Cycle/, accessed 4 September 2018.