Nordhaus: The political business cycle
Disclaimer. Don't rely on these old notes in lieu of reading the literature, but they can jog your memory. As a grad student long ago, my peers and I collaborated to write and exchange summaries of political science research. I posted them to a wiki-style website. "Wikisum" is now dead but archived here. I cannot vouch for these notes' accuracy, nor can I say who wrote them.
Nordhaus. 1975. The political business cycle. Review of Economic Studies 42: 169-190.
The Political Problem: Political Business Cycles
THE BASIC PROBLEM: politicians in democracies have little reason to value future (post-election) consumption. Thus, although private investors can sacrifice short-term consumption to make long-term investments, public investors (politicians) have difficulty doing so. The general pattern is to see a degree of macroeconomic austerity towards the beginning of a politician's term, then lots of spendinig at the end (to get ready for the election).
According to the widely-accepted (at the time) but now discredited Philips curve, there is a trade-off between unemployment and inflation.
Possible Solutions
- Educate citizens about long-term economic needs: Probably not a practical solution.
- Make terms longer: might help, but doesn't eliminate the bias against long-term planning.
- Delegate to an autonomous agency: although we regularly delegate monetary policy to a central bank, delegating fiscal policy to the Treasury would be more complicated--and it would risk making it too difficult to respond to pressing policy problems.
- Lower the slope on the Philips curve (i.e. reduce the tradeoff between unemployment and inflation) by (a) assisting those hurt by inflation or (b) implementing an "income policy," like wage and price controls. This would be difficult in a liberal market economy, and besides, there would still be myopic public policy in other realms.
- Broaden the base of participation in planning the economy. States that require the government to publish a formal long-term plan for the economy (in consulation with the opposition and technocrats), like France and Sweden, have less of a political business cycle than states with unplanned economies (US, Canada, Japan, W. Germany). (Possible criticism: Although the authors endorse this solution, I can't help noticing that the states with the unplanned economies are more successful economically--even if they do suffer from the cycling problem.)
Summary of the Argument
In the long run:
- Y: How much we think about the future when we make macroeconomic decisions (especially the trade-off between unemployment and inflation). (Long-term planning is better than short-sightedness.)
In the short run:
- Y: The trade-off between unemployment and inflation
- X: Myopic retrospective voting (affected by the length of the election period; perhaps also by timing of election)
Philips curve [now discredited]: There's a tradeoff btw inflation and unemployment.
- Low unemployment leads to rising wages, which leads to higher inflation.
- Mostly a short term tradeoff.
Microfoundations:
- Voters don't like aggregate unemployment or inflation (a bit weak here)
- Voters don't necessarily see a tradeoff btw these
- Voters vote retrospectively (vote for or against the incumbent)
- Government chooses policies to maximize reelection
In the long run, we discount the future too heavily, so voters want lower unemployment and higher inflation than is optimal.
In the short run, we see the political business cycle. But here's where myopia comes in: when evaluating an incumbent, voters consider recent performance more than earlier performance.
- Thus, just before each election, unemployment will be lowered to the perfectly myopic point (where we discount the future completely).
