The Fed-Induced Political Business Cycle

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

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy; Political business cycle; Wavelet
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies

References

Abrams, B.A., Iossifov, P., 2006. Does the Fed contribute to a political business cycle? Public Choice 129, 249-262.

Abrams, B.A., Butkiewicz, J.L., 2012. The political business cycle: new evidence from the Nixon tapes. Journal of Money, Credit and Banking 44, 385-399.

Acemoglu, D., Johnson, S., Querubin, P., Robinson, J.A., 2008. When does policy reform work? The case of central bank independence. Brookings Papers on Economic Activity 1, 351-418.

Aguiar-Conraria, L., Martins, M., Soares, M. J., 2012. The yield curve and the macro-economy across time and frequencies. Journal of Economic Dynamics and Control 36, 1950-1970.

Aguiar-Conraria, L., Soares, M. J., 2014. The Continuous Wavelet Transform: moving beyond uni- and bivariate analysis. Journal of Economic Surveys 28, 344-375.

Alesina, A., Roubini, N., 1992. Political cycles in OECD economies. Review of Economic Studies 59, 663-688.

Alesina, A., Cohen, G.D., Roubini, N., 1992. Macroeconomic policy and elections in OECD democracies. In Cukierman, A., Hercovitz, Z., Leiderman, L. (Eds.), Political economy, growth, and business cycles, Cambridge, MIT, 227-262.

Alesina, A., Summers, L.H., 1993. Central bank independence and macroeconomic performance: some comparative evidence. Journal of Money, Credit and Banking 25, 151-162.

Alesina, A., Roubini, N., Cohen, G.D., 1997. Political Cycles and the Macroeconomy. Cambridge, MIT.

Allen, S.D., McCrickard, D.L., 1991. The influence of elections on federal reserve behavior. Economics Letters 37, 51-55.

Beetsma, Roel M.W.J., Bovenberg, A.L., 1997. Central bank independence and public debt policy. Journal of Economic Dynamics and Control 21, 873-894.

Clarida, R., Galí, J., Gertler, M., 2000. Monetary policy rules and macroeconomic stability: evidence and some theory. Quarterly Journal of Economics CXV, 147-180.

Faust, J., Irons, J.S., 1999. Money, politics and the post-war business cycle. Journal of Monetary Economics 43, 61-89.

Frey, B.S., Schneider, F., 1981. Central bank behaviour: a positive empirical analysis. Journal of Monetary Economics 7, 291-315.

Funashima, Y., 2013. Reassessing the Fed’s behaviour towards presidential elections. Applied Economics Letters 20, 795-798.

Grier, K., 2008. US presidential elections and real GDP growth, 1961-2004. Public Choice 135, 337-352.

Jones, A.T., Snyder, M.W., 2014. Federal Reserve independence: the Fed Funds Rate under different regimes, Applied Economics Letters 21, 1262-1265.

Marczak, M., Gómez, V., 2015. Cyclicality of real wages in the USA and Germany: new insights from wavelet analysis, Economic Modelling 47, 40-52.

McCallum, B.T., 1997. Crucial issues concerning central bank independence. Journal of Monetary Economics 39, 99-112.

Milani, F., 2010. Political business cycles in the new Keynesian model. Economic Inquiry 48, 896-915.

Nordhaus, W., 1975. The political business cycle. Review of Economic Studies 42, 169-190.

Rogoff, K., 1985. The optimal degree of commitment to an intermediate monetary target. Quarterly Journal of Economics 100, 1169-1189.

Rogoff, K., 1990. Equilibrium political budget cycles. American Economic Review 80, 21-36.

Rua, A., 2012. Money growth and inflation in the Euro area: a time-frequency view. Oxford Bulletin of Economics and Statistics 74, 875-885.

Tempelman, J.H., 2007. A commentary on “Does the Fed contribute to a political business cycle?” Public Choice 132, 433–436.

Walsh, C.E., 2003. Monetary Theory and Policy, 2nd edition. MIT Press, Cambridge, MA.

Weymark, D.N., 2007. Inflation, government transfers, and optimal central bank independence. European Economic Review 51, 297-315.