Is the Political Business Cycle for Real?

Abstract

This paper constructs and examines a macroeconomic model which combines features from both real and political business cycle models. Our goal is to augment a standard real business cycle tax model by introducing political leaders who possess heterogeneous preferences for taxation and uncertain levels of competence to replicate two important empirical regularities: First, that the economy expands early under Democratic Presidents. Second, that Presidents whose parties successfully retain the presidency have stronger than average growth in the second half of their terms.

The economic and political implications from this model conform to Post World War II data. Key features of the model are as follows: when Democratic Presidents are elected, the representative agent knows that they will increase government services and hence will expect taxes to rise in the future causing him to substitute labor for leisure in the current period in anticipation of policy change. If the President is incompetent and uses the tax revenue inefficiently while in office, then in the future period, real activity will fall sharply, and the President will fail in his re-election bid. However, if the President uses the tax revenue efficiently, neither recession nor loss in election will occur. The opposite dynamic response follows the election of Republican Presidents.

JEL Classification: H1, H5, H8