39 Pages Posted: 23 Jun 2014
Date Written: June 1, 2014
American politics have become extremely polarized in recent decades. This deep political divide has caused significant government dysfunction. Political divisions make the timing, size, and composition of government policy less predictable. According to existing theories, an increase in the degree of economic policy uncertainty or in the volatility of fiscal shocks results in a decline in economic activity. This occurs because businesses and households may be induced to delay decisions that involve high reversibility costs. In addition, disagreement between policymakers may result in stalemate, or, in extreme cases, a government shutdown. This adversely affects the optimal implementation of policy reforms and may result in excessive debt accumulation or inefficient public-sector responses to adverse shocks. Testing these theories has been challenging given the low frequency at which existing measures of partisan conflict have been computed. In this paper, I provide a novel high-frequency indicator of the degree of partisan conflict. The index, constructed for the period 1891 to 2013, uses a search-based approach that measures the frequency of newspaper articles that report lawmakers' disagreement about policy. I show that the long-run trend of partisan conflict behaves similarly to political polarization and income inequality, especially since the Great Depression. Its short-run fluctuations are highly related to elections, but unrelated to recessions. The lower-than-average values observed during wars suggest a "rally around the flag" effect. I use the index to study the effect of an increase in partisan conflict, equivalent to the one observed since the Great Recession, on business cycles. Using a simple VAR, I find that an innovation to partisan conflict increases government deficits and significantly discourages investment, output, and employment. Moreover, these declines are persistent, which may help explain the slow recovery observed since the 2007 recession ended.
Keywords: Economic policy, Partisan conflict, Politics, Polarization, Business cycles
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