Politics and Fiscal Policy

Monty Douglas

November 28, 2010

BA206 Macroeconomics

Politics and Fiscal Policy

Suppose that fiscal policy changes output faster than it changes the price level. How might such timing play a role in the theory of political business cycles? A political business cycle is a business cycle that results primarily from the manipulation of policy tools (fiscal policy, monetary policy) by incumbent politicians hoping to stimulate the economy just prior to an election and thereby greatly improve their own and their party's reelection chances. Expansionary monetary and fiscal policies have politically popular consequences in the short run (tax cuts, falling unemployment, falling interest rates, new government spending on services for special interests, etc.). Unfortunately these very policies, especially if pursued to excess, can also have very unpleasant consequences in the longer term (accelerating inflation, an unsustainably low rate of savings to support future investment, damage to the foreign trade balance, long-term expansion of government's share of the GNP at the expense of people's disposable incomes, etc.). So immediately after the election is over (and the next election is far away), politicians tend to “bite the bullet” and reverse course by raising taxes, cutting spending, slowing the growth of the money supply, allowing interest rates to rise, etc. Thus the regular holding of elections tends to produce a boom-and-bust pattern in the economy because of the on-again-off-again pattern of government stimulus and restraint encouraged by trying to schedule an artificial boom at every election time.

Is this a valid role for fiscal policy? Yes, given the effects of fiscal policy, particularly in the short run, we should not be surprised that elected officials might try to use it to get reelected. The link between economic performance and reelection success has a long history. Ray Fair of Yale University examined presidential elections dating back to...