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The Fed-Induced Political Business Cycle

Funashima, Yoshito (2015): The Fed-Induced Political Business Cycle.

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Given that Nordhaus' political business cycle theory is relevant at election cycle frequency and that its validity can change over time, we consider wavelet analysis especially suited to test the theory. For the postwar U.S. economy, we exploit wavelet methods to demonstrate whether there actually exists an opportunistic political business cycle in monetary policy by allowing for time-varying behavior and by introducing the frequency-domain perspective. Our results indicate an inclination of the Federal Reserve to cut the Funds rate prior to presidential elections except for the 1990s. Moreover, such political manipulation is shown to significantly affect output in not only the famous Burns-Nixon era but also the Volcker-Reagan era. The outcomes are robust even when the effects of government spending are controlled for.

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