An Empirical Study of Politico-Economic Interaction in the United States: A Reply

Abstract

N modern society, where government has assumed a major role in economic affairs and where the electorate has made it increasingly responsible for material well-being, it has become important to analyse the interaction between economic and political systems. Government should no longer be regarded as exogenous to the economic system. This is particularly the case with respect to econometric model building. As some authors have noted, an econometric model may be subject to serious misspecification if an endogenous variable (such as government expenditure) is treated as if it were exogenous.' The study of politico-economic interdependence also has important consequences for forecasting. As the future course of economic events is strongly dependent on government action, existing macroeconometric models that regard government as exogenous are of limited use for prediction. Furthermore, economic policy advice is often unsuccessful because it does not take political repercussions into account. A deflationary policy, for example, will hardly be adopted by a government just before an election because it carries with it a high risk of leading to government's losing the election. Politicoeconometric modelling helps economists concerned with government advising to advance proposals that have a reasonable chance of being put into action. This study puts forward some simple theoretical hypotheses concerning the nature of the interrelationship between the economy and the polity, particularly with respect to (central) government. The basic relationships are reflected in the popularity function, which describes the impact of economic conditions on government popularity; and in the reaction function, which shows how government uses policy instruments to steer the economy in a desired direction. These relationships are econometrically tested with quarterly data for the United States for the period 1953-1975. In the model both voters and government are assumed to be utility maximizers, and government's behavior is restricted by various economic, political and administrative constraints. The analysis shows that the government's (or in the case here dealt with, the president's) popularity is significantly reduced when the rate of unemployment and/or of inflation rises, and that it is significantly increased when the growth rate of private consumption rises. Government reacts to changes in its popularity because this is taken as an indicator of future electoral outcome. When popularity is low, it tries to steer the economy so as to increase its re-election chances; when popularity is high enough, it can afford to pursue ideologicallyoriented policies, which need not always be popular with the electorate. There have been a number of papers that have dealt with the influence of economic variables on election outcomes and on government popularity, most of which are unsatisfactory on theoretical and statistical grounds. There are, on the other hand, only a few that have been concerned with government reaction functions. Moreover, these studies have been either apolitical and interested only in the implied weights of a welfare function (e.g., Friedlaender, 1973); or they have related to only a particular section of the economy (e.g., Received for publication June 14, 1976. Revision accepted for publication November 30, 1976. * University of Zurich. A first version of this paper was written during a stay at the Cowles Foundation, Yale University. It was revised in the light of comments received when it was presented at the Cowles Foundation Seminar and at seminars at Princeton University, the University of North Carolina at Chapel Hill and the Center for Study of Public Choice, Virginia Polytechnic Institute and State University. The authors are especially grateful to A. S. Blinder, J. M. Buchanan, R. C. Fair, G. M. Heal, D. F. Hendry, C. Goodrich, G. H. Kramer, G. Kirchgaessner, D. MacRae, W. D. Nordhaus, W. E. Oates, E. R. Tufte, G. Tullock, R. Wagner, and to the anonymous referees. ' See Crotty (1973), Goldfeld and Blinder (1972), Blinder and Solow (1974, pp. 69-77).