Hyperbolic Memory Discounting and the Political Business Cycle

Abstract

The vintage political business cycle framework of Nordhaus (1975) represents the idea that the macroeconomic business cycle is manipulated opportunistically by an incumbent government to achieve re-election. A key assumption in this prototypical framework is that voters discount their memories about unemployment and inflation at a constant rate. Yet starting with Ebbinghaus (1885) and Jost (1897), a large body of research in psychology documents an empirical regularity that has come to be known as Jost's Second Law of Forgetting --- individuals discount recent memories at a higher rate compared to the rate at which they discount older memories. I find that incorporating this insight from psychology (i.e., hyperbolic memory discounting) into the benchmark framework moderates the amplitude of the predicted political business cycle.