Partisan Business Cycles Research Articles

The Partisan Business Cycle and Firm Value: Toward Political Economy of Firm Valuation

Our research probes the firm valuation impact of partisan-motivated policy cycles. We first identify the micro-channels of policy transmission that link partisan policy disturbances to firm value. Then, we draw on firm-level data from 21 industrial democracies for the period extending from 1989 to 2008 to examine whether government partisanship has any distinct impact on firm value. We identify a surprisingly large and consistent positive relationship of left-oriented governments with firm value. Additionally, our research finds that the partisan impact on firm value is appreciably conditioned by factors like economic openness.

Partisan Social Happiness

We use a new approach to study questions in political economy that relies on data on the subjective well-being of a large sample of people living in the OECD over the period 1975‐1992. Controlling for the personal characteristics of the respondents, year and country fixed effects and country-specific time trends, we find that the data describe social happiness functions for left-wing and right-wing individuals where inflation and unemployment enter negatively. We use these functions to test the root assumption of partisan business cycle models. The evidence is consistent with the hypothesis that left-wing individuals care more about unemployment relative to inflation than right-wingers. Interestingly, we find that individuals declare themselves to be happier when the party they support is in power, even after controlling for macroeconomic variables. The effect of politics is large. Finally, we find that these partisan differences cannot be traced back to income differences. That is, it is misleading to assume—as it is done in the previous literature—that the poor (rich) behave similarly to the left (right). For example, inflation and unemployment do not have differential effects across rich and poor and the happiness levels of these two groups are unaffected by the identity of the party in power. Our findings are hard to explain using median voter models but are to be expected in a partisan world.

Political Business Cycles and Central Bank Independence

This paper develops a dynamic model of Rational Partisan Business Cycles in which wage contracts overlap elections and wage setters have to make a prediction about the election result. Empirical analysis of 20 OECD countries supports the theoretical implication that left wing incumbents increase output, but increased expectation of a left wing regime reduces it. The model is extended to incorporate the effects of alternative measures of Central Bank Independence (CBI). The measure of objective independence outperforms the other measures and it is found that CBI reduces politically induced business cycles.

Ambiguity and Partisan Business Cycles

We introduce ambiguity (Knightian uncertainty) into a stripped-down version of Alesina's (1987) partisan model of the business cycle. We show that, if the private sector's subjective expectations of future events are ambiguous, there is the possibility of a political business cycle, even when the parties running for the election have similar preferences for inflation and unemployment. In particular, if inflation is perceived as a loss, then the larger the fraction of the population that is ambiguity-prone (-averse), the larger is the postelection boom (slump), with unemployment then returning back to its natural level. We also show that, for given parties preferences, ambiguity proneness (aversion) implies smaller (larger) fluctuations in the unemployment around its natural level when the right-wing party wins the elections. (Keywords: Ambiguity, Ellsberg's paradox, Partisan theory of the business cycle, Unemployment)

Variable Rational Partisan Business Cycles: theory and some evidence

The Variable Rational Partisan Business Cycle model is developed, where agents face uncertainty regarding the timing and outcome of the next election. The model predicts that partisan influences on the economy persist throughout the government’s rule and are further influenced, in the opposite direction, by which party ruled in the previous period. Party popularity also has a causal effect on the business cycle. Finally, the effects from changes in election timing expectations are dependent on which party ruled in the previous period. Empirical results for output and unemployment in Canada, Germany, and United Kingdom yield mixed support for the model. JEL Classification: D72, E32 Le modèle des cycles d’affaires variables fondé sur le comportement du partisan rationnel : théorie et résultats. Le modèle de cycles d’affaires variables fondé sur le comportement du partisan rationnel est développé pour le cas où les agents font face à de l’incertitude quant au moment du déclenchement des élections et quant aux résultats des prochaines élections. Le modèle prédit que les influences partisanes sur l’économie persistent tout au long du mandat du gouvernement, et qu’elles sont influencées, dans la direction opposée, par le type de parti au pouvoir au cours du mandat antérieur. La popularité du parti a un effet de causalité sur le cycle d’affaires. Enfin les effets des changements dans les anticipations du moment du déclenchement des élections dépendent de quel parti était au pouvoir au cours de la période antérieure. Les résultats empiriques de la calibration du modèle pour la production et le chômage au Canada,en Allemagne et au Royaume Uni donnent des résultats mitigés.

Politics and Unemployment in Industrialized Democracies

This paper provides an empirical appraisal of the influence ofpolitics on the evolution of unemployment rates in 13industrialized democracies (12 European Union countries andthe U.S.) from 1960 to 1999. We conduct new tests ofopportunistic and partisan business cycle models, using richerdata and more general specifications than previous studies. Incontrast to most previous studies, we pay particular attentionto the importance of labor market structure in conditioningthe influence of politics on unemployment. We also investigatethe relationship between political stability and economicstability. The results suggest the existence of partisan effects, withhigher unemployment rates prevailing under ``right'' partiesthan ``left'' parties. There is more support for ``rational''partisan models that embody transient partisan impacts thanfor models with permanent effects. We find evidence that unionpower is associated with higher average unemployment rates,but that centralized bargaining institutions tend to lowerunemployment rates. The evidence also suggests that morefragmented coalition governments are associated with higherunemployment rates than single party governments.

Electoral Uncertainty and the Macroeconomy: the Evidence from Canada

The partisan advantage and incumbency advantage versions ofthe rational partisan business cycle model are tested. Bothmodels assume agents form weighted averages of partisaninflation rates during an election period, and differ only inhow the weights are formed which alters the form of businesscycles. The partisan advantage assumes fixed weightsdesignated for both major parties in each election, whereasthe incumbency advantage model assumes fixed weights forwhichever is the incumbent and opposition party in eachelection. The symmetric representation assumes each electionis a toss-up. Strongest support is found for a temporarysymmetric effect on the level of output, but none of themodels are supported for temporary electoral changes in growthor unemployment rates.

Partisan Social Happiness

We use data on the subjective well-being of more than a quarter of a million people living in the OECD over the period 1975-92 to study the behavior of partisan social happiness functions. Controlling for personal characteristics of the respondents, year and country fixed effects and country specific time trends, we find that the data describe social happiness functions for left-wing and right-wing individuals where inflation and unemployment enter negatively. We use these functions to test the root assumption of partisan business cycle models where left-wing individuals care more about unemployment relative to inflation than right-wingers. Bootstrap confidence intervals suggest that up to 90 per cent of the time the evidence is consistent with this assumption. Interestingly, we find that it is misleading to assume that the poor (rich) behave similarly to the left (right). For example, the poor are hurt more by inflation than the rich, while the left are hurt less. Finally, we find that individuals declare themselves to be happier when the party they support is in power, even after controlling for economic variables. Our findings are hard to explain using median voter models but are to be expected in a partisan world.

Partisan business cycles under variable election dates

This paper develops a model where rational economic agents face uncertainty regarding the timing of elections and which party will emerge victorious should an election occur. This electoral uncertainty affects the macroeconomy, where the size and direction of the impacts are dependent on the party in power in the current and previous period, time elapsed since the last election, and party popularity. Leftist governments are expected to sustain higher output levels throughout their electoral term compared to right-wing governments, and the partisan differences will continue to increase until the next election.

Policy Boards and Policy Smoothing*

Partisan politics and random election outcomes generate policy uncertainty and partisan business cycles. To reduce policy uncertainty, society must design the policy-making environment to overcome electoral uncertainty and partisanship. I show that delegating policy to an independent policy board with discretionary powers will produce substantial policy smoothing and lower policy uncertainty relative to a simple model in which elected officials set policy. Board members are chosen in a partisan, noncooperative environment; yet in the benchmark model, policy variability is eliminated, and the cooperative bargaining solution is replicated.

Comment on ‘The Politics of the Political Business Cycle’

In a thought-provoking paper, Schultz develops an idea first put forward in a number of papers by Frey and Schneider and argues that governments will have less incentive to manipulate the economy when they lead in the polls. This helps to explain why electoral cycles have been so hard to detect. As other authors have observed, the best evidence suggests that electoral cycles (in output or instruments) are weak and irregular. Kenneth A Schultz ‘The Politics of the Political Business Cycle’, British Journal of Political Science, 25 (1995), 79–99. For example, Bruno Frey and Friedrich Schneider, ‘A Politico-Economic Model of the United Kingdom’, Economic Journal, 88 (1978), 243–53. Frey and Schneider were subjected to a severe critique at the time: see Alec Chrystal and James Alt, ‘Public Sector Behaviour: The Status of the Political Business Cycle’, in David Currie, Robert Nobay and David Peel, eds, Macroeconomic Analysis (London: Croom Helm, 1981). Alberto Alesina, ‘Macroeconomic policy in a Two-Party System as a Repeated Game’ Quarterly Journal of Economics, 102 (1987), 651–78; Alberto Alesina ‘Macroeconomics and Politics’, NBER Macroeconomics Annual (Cambridge, Mass: MIT Press, 1988); Alberto Alesina ‘Evaluating Rational Partisan Business Cycle Theory: A Response’, Economics and Politics, 5 (1990), 1–30; Alberto Alesina, G. Cohen and N. Roubini, ‘Electoral Business Cycles in Industrial Democracies’, European Journal of Political Economy, 9 (1993) 1–23; Stephen Sheffrin, ‘Evaluating Rational Partisan Business Cycle Theory’. Economics and Politics, 1 (1989) 239–60.

EVALUATING RATIONAL PARTISAN BUSINESS CYCLE THEORY*

This paper provides new tests of the recently developed theory of rational partisan business cycles. According to the theory, resolution of uncertainty about electoral consequences and partisan differences in economic behavior produce downturns following victories of conservative parties and booms following victories of liberal parties. The first tests utilize the behavior of financial markets to reassess the evidence for the United States. We provide evidence that the stock market does have predictive power for output and estimate an econometric relationship which is then used to gauge the extent to which the recessions are anticipated after elections. The second test uses an international sample of democracies in the postwar era to examine the theory outside the United States using time series models and political variables. The results of the tests provide little support for a strict interpretation of the theory.