Friday, April 25, 2008

Rediscovering partisan cycles 

Many people are talking about Larry Bartels new book, Unequal Democracy. Paul Krugman talks about the differences in inequality between GOP and Democrat administrations, but he can't figure out why that happens. Dani Rodrik seems to accept Bartels' explanation of why voters still vote for Republicans when they keep giving us recessions and income inequality, which is that voters are myopic. (Russ Roberts calls the data into question -- well worth considering, but not my point.)

Alex Tabarrok makes the key point: We've known this result for some time.
In a nutshell, the theory of partisan business cycles says that Democrats care more about reducing unemployment, Republicans care more about reducing inflation. Wage growth is set according to expected inflation in advance of an election. Since which party will win the election is unknown wages growth is set according to a mean of the Democrat (high) and Republican (low) expected inflation rates. If Democrats are elected they inflate and real wages fall creating a boom. If Republicans are elected they reduce inflation and real wages rise creating a bust.
A certain economist wrote his dissertation on political business cycles in the 1980s and considered partisan cycles. I didn't have at that time the nice chart that Alberto Alesina and Howard Rosenthal (Am Pol Sci Rev, 1989) drew that Alex has updated, but I had noted what they note in their introduction. Democratic and Republican candidates have "polarized policy preferencs" in that Democrats have a higher tolerance for inflation and a lower tolerance for unemployment than do Republicans." (pp. 374-75) There are also economic frictions caused by the presence of wage contracts, that must be set during the period where we don't know whether the Republican or Democrat will win. Because these contracts can be rewritten after the election, most of the shock that occurs when one side or the other wins an election happens in the first half of the new administration; ergo, partisan cycles are the result of settling electoral choices. Unlike earlier political business cycle models, you can generate these results while still having completely rational voters. What they lack is only knowledge of how everyone else in the economy will vote.

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