Political Business Cycles and Their Policy Implications: An Extension of Alesina`s Model

Abstract

This paper reviews and empirically tests the most recent theoretical and empirical work on political business cycles in the United States. It focuses on the rational partisan theory of Alesina et al. (1997) and extends their data from 1994 to 2005. We tested three different political business cycle modles-the opportunistic, traditional partisan, and rational partisan models-to observe whether they remain valid. Overall, our results show that the rational partisan model outperforms both the opportunistic model and the traditional partisan modls in explaining the variations of monetary and fiscal policy outcomes, which are consistent with Alesina et al.'s work (1997). More specifically, we found a significant partisan effect on money growth, a weak partisan effect on the federal funds rate, and no partisan effect on other interest rates including the discount rate, three-month Treasury bill, and ten-year Treasury note. Our finding on the partisan effects of money growth resemble those of Alesina (1988), but our results on interest rates differ. In addition, we found a strong partisan effect on the budget deficit (higher during republican administrations) and no partisan effect on the level of government transfers. Both findings are consistent with Alesina's work (1988). Future research is required to identify how partisan effects vary across both developed and developing countries and how stock market performance and the role of the central bank during presidential elections are related.