Estimating the Cost of Social-Democratic Government by Regression-Discontinuity Analysis of Close Elections

Abstract

This paper employs a regression-discontinuity (RD) design to ascertain the effects of social-democratic government on fiscal policy (budget deficits) and monetary policy (as reflected in inflation) and on currency and bond prices (i.e., exchange rates and yields). The RD design exploits the essentially random application of a treatment - in this case, social-democratic parties gaining government - near a discontinuous break in the probability of receiving that treatment - in this case, a discontinuous rise in the probability of entering government occurs as the social-democratic party seat-share crosses the plurality threshold - to identify and estimate the causal effect of the treatment (social-democratic government). One advantage of the RD design for researching these questions is that RD does not require, as have previously employed strategies, strong assumptions about if, how, or when market actors form political expectations, or about the quality and dissemination of political information, or about functional forms or explanatory-variable selection. Instead, the strategy relies on balancing observed and unobserved characteristics of the cases near the discontinuity on either side. Our findings suggest no or small and insignificant partisan-government effects except for a small and very short-term (one month), but statistically significant, currency-depreciation resulting from assumption of governmental power of social-democratic parties following close elections.

Keywords: Regression Discontinuity Design, Social Democratic Government, Financial Markets

JEL Classification: C1, C14, F3, G14, G15, H6