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10.8 The Decline and Renaissance of Opportunistic and Partisan Models

The 1970s were a turbulent time for the capitalist democracies as the ‘Golden

Age’ of low inflation, low unemployment and above average growth came to

an end. The stagflation crisis of the 1970s also brought to an end the Keynesian

consensus which had dominated macroeconomic theory and policy making in

the quarter-century following the Second World War. In the wake of the

monetarist counter-revolution, Lucas inspired a rational expectations revolution

in macroeconomics. By the mid-1970s models which continued to use

the adaptive expectations hypothesis were coming in for heavy criticism from

new classical theorists, as the hypothesis implies that economic agents can

make systematic errors. In market-clearing models with rational expectations

the assumption that economic agents are forward-looking makes it more

difficult for the policy maker to manipulate real economic activity. There is

no exploitable short-run Phillips curve which policy makers can use. Preelection

monetary expansions, for example, will fail to surprise rational agents

because such a manoeuvre will be expected.

The rational expectations hypothesis also implies that voters will be forward-

looking and will not be systematically fooled in equilibrium. According

to Alesina (1988), ‘the theoretical literature on political business cycles made

essentially no progress’ after the contributions of Nordhaus (1975), Lindbeck

(1976) and MacRae (1977) because of the ‘devastating’ effect of the rational

expectations critique. The Nordhaus model involves an exploitable short-run

Phillips curve trade-off combined with myopic voters. Once the rational

expectations hypothesis is introduced, however, voters can be expected to

recognize the incentives politicians have to manipulate the economy for

electoral profit. Given that US presidential elections are held on a regular

four-year basis, it is difficult to believe that rational voters and economic

agents would allow themselves to be systematically duped by the macroeconomic

manipulations of self-interested politicians. Moreover, it is difficult to

reconcile the predictions of the Nordhaus model with situations where monetary

policy is conducted by an independent central bank, unless government

can in some way pressurize the central bank to accommodate the incumbent

government’s preferred monetary policy (on this see Havrilesky, 1993; Woolley,

1994). However, Blinder, in discussing this issue, denies that political pressure

was an issue during his period as Vice Chairman at the US Federal

Reserve, 1994–6. In his experience the political influence on monetary policy

was ‘trivial, next to zero’, although he agrees that this was not the case during

the Richard Nixon–Arthur Burns era (see Snowdon, 2001a).

The Hibbs model also has major theoretical shortcomings, especially with

respect to the stability of the Phillips curve trade-off implicit in his analysis.

Remarkably, Hibbs makes no mention of the expectations-augmented Phillips

curve in his 1977 paper even though the Friedman–Phelps theory was a

decade old and by then a well-established idea, even among Keynesians (see

Gordon, 1975, 1976; Blinder, 1988b, 1992a; Laidler, 1992a). The assumption

of rationality also has implications for the Hibbs model. Since the output and

employment effects of expansionary and contractionary demand management

policies are only transitory in new classical models, the identification of

partisan influences on macroeconomic outcomes will be harder to detect (see

Alesina, 1989). Alt (1985) concluded that partisan effects are not permanent

but occur temporarily after a change of government.

In addition to the theoretical shortcomings of the early political business

cycle literature, the Nordhaus model also failed to attract strong empirical

support, with the econometric literature yielding inconclusive results (see

Mullineux et al., 1993). While McCallum (1978) rejected the implications of

the Nordhaus model for US data, Paldam (1979) could only find weak evidence

of a political business cycle in OECD countries. Later studies, such as those

conducted by Hibbs (1987), Alesina (1988, 1989), Alesina and Roubini (1992),

Alesina and Roubini with Cohen (1997) and Drazen (2000a, 2000b), also find

little evidence of a political business cycle in data on unemployment and GNP

growth for the US and other OECD economies. This also applies where the

timing of elections is endogenous (see Alesina et al., 1993). More favourable

results for the Nordhaus model are reported by Soh (1986), Nordhaus (1989),

Haynes and Stone (1990) and Tufte (1978), who found some evidence of preelection

manipulation of fiscal and monetary policy for the USA. In addition,

Drazen (2000a) distinguishes between empirical predictions that focus on policy

outcomes (inflation, unemployment, growth) and those that focus on policy

instruments (taxes, government expenditure interest rates) and concludes that

‘the evidence for opportunistic manipulation of macroeconomic policies is

stronger than for macroeconomic outcomes’. With respect to policy outcomes

there is more support for the opportunistic political business cycle theory

coming from post-electoral inflation behaviour than can be found in the preelectoral

movement of real GDP and unemployment. Drazen also concludes

that the evidence in favour of opportunistic manipulation of policy instruments

is much stronger for fiscal policy than it is for monetary policy.

A significant problem for partisan theories in general is the argument and

evidence presented by Easterly and Fischer (2001) that low inflation helps the

poor more than the rich. Inflation acts as a financial tax that hits the poor

disproportionately because they tend to hold more of their wealth in cash

relative to their income than the rich, whereas the rich are more likely to have

access to various financial instruments that allow them to hedge against

inflation. In addition the poor obviously depend more on minimum wages

and state-determined income payments that are not always indexed to protect

against the effects of inflation (see Snowdon, 2004b). Easterly and Fischer

present evidence drawn from an international poll of over 30 000 respondents

from 38 countries and the responses indicate that the poor themselves are

more strongly averse to inflation than those with higher incomes. This undermines

a key assumption of Hibbs’s model that the rich are more inflation-averse

than the poor.

By the mid-1980s the politico-economic literature had reached a new ebb.

Zarnowitz (1985), in his survey of business cycle research, devotes one

footnote to the idea of an electoral cycle and refers critically to the ‘strong’

and ‘questionable’ assumptions of such models as well as the lack of supporting

evidence. The same neglect is also a feature of Gordon’s (1986) edited

survey of The American Business Cycle.

Following a period of relative neglect, the literature on the relationship

between politics and the macroeconomy underwent a significant revival since

the mid-1980s (see Willet, 1988). Economists responded to the rational expectations

critique by producing a new generation of rational politico-economic

models. Like the first phase in the 1970s, the second phase of politicoeconomic

models consisted of opportunistic and partisan versions of the

interaction between politics and the macroeconomy. In the next two sections

we examine the main features of rational political business cycle models and

the rational partisan theory.