Political Cycles and their Suboptimal Equilibrium

This work aims at providing new evidence on the existence of the so called “political business cycle” hypothesis, building on the work of Alesina and Roubini (1997). To this end, we build a new data-set for the period 1947-2010 including 18 OECD countries. In the United Sates, we find evidence of political cycles that support the rational partisan theory. Hence, after a change of regime from a Democratic (Republican) to a Republican (Democratic) administration, there is a temporarily decrease (increase) in output growth and increase (decrease) in unemployment. Nevertheless, such partisan effects seem to decrease in their size in the last two decades. Furthermore, for the United States, there is no partisan effect on the inflation rate for the entire sample period. Looking at 18 OECD countries, support is found for the rational partisan theory on output growth and unemployment. Contrary to the United States, in the 18 OECD countries there is significant evidence of partisan effects on the inflation rate. Hence, the inflation is permanently higher (lower) than the natural rate during a left (right) wing administration. In addition, we find evidence of a political business cycle in the form of a temporally increase in output growth before an election. This finding – which is primarily fueled by the last two to three decades - only indirectly supports the possible existence of an opportunistic policy maker. Introduction