A note on the electorate's most preferred inflation rate

Abstract

Nordhaus (1975) and MacRae (1977) have articulated theories of the political business cycle which allow one to estimate an inflation rate that is optimal in the sense that it will maximize the chance of a political party remaining in power. Central to the notion of a political business cycle is a preference function or iso-vote loss curve which reflects the willingness of the electorate to endure extra unemployment for the sake of a lower inflation rate. The authors assume that this tradeoff function is well behaved and can be approximated by a parabola or half circles. The electorate's most preferred inflation rate can be defined as that rate which will maximize the chance of an incumbent political party getting reelected for any possible variation in the unemployment rate. It is also the inflation rate which would presumably prevail in a democratic society if unemployment were not a problem. In constructing their voter preference curves involving a tradeoff between inflation and unemployment Nordhaus and MacRae both assumed that price stability, other things equal, is preferred by the electorate to either inflation or deflation. Alan Greenspan, has indicated that he and other governors of the Federal Reserve share this view and are willing to support a bill sponsored by Representative Stephen Neal which would require the Fed to pursue polices aimed at eliminating inflation within five years (Wessel, 1989). When parabolas representing a non "turnover contour" curve are fit to the election year inflation and unemployment rates which encompass all those cases where the incumbent political party did not loose the presidential election, however, the conclusion is that the most preferred inflation rate is positive and has been trending upward over time. The basic data on inflation, unemployment and the outcome of presidential elections from 1920-88 are presented in Table 1. For the entire period one can encompass all those non turnover cases where the incumbent political party did not loose the election by fitting a simple parabola to the data points for 1928, 1936 and 1988. Where U is the unemployment rate and P is the inflation rate,