Mark Thoma: How Much Do Election Shakeups Affect the National Economy?
[Mr. Thoma is associate professor of economics at the University of Oregon and an economics blogger.]
In the last 30 years, a considerable amount of work has been devoted to an area of economics known as "political business cycles." Researchers in this area look at the relationship between electoral outcomes -- the outcome of elections and the economic policies of the party in power -- and the subsequent performance of the economy.
Broadly stated, there are two kinds of research on political business cycles. One type watches how the parties that win elections -- or are in control -- affect the performance of the economy. (For an overview of seminal work in this area see this paper by Allan Drazen. Also, see more recent papers here, here and here.)
The other class of research looks at the question from the opposite side. These researchers study how the performance of the economy helps decide which party wins an election. (For a good grounding in this type of work, see some important papers here and here.)
Here are some large research findings as summed up by Drazen:
• Inflation -- In the U.S., there is evidence of a post-electoral increase in inflation prior to 1979, but no evidence thereafter.
• Monetary Policy -- There is evidence of a pre-electoral increase in money growth rates from 1960 to 1980, but none thereafter. Money growth, or the percentage change in money supply, is an important measure of monetary policy prior to 1980, when the Fed started to focus on the federal-funds rate as the main monetary policy tool. There is no evidence for the U.S. of an electoral cycle in the federal-funds rate.
• Spending on Programs -- There is evidence of pre-electoral increases in government transfers (such as food stamps, Social Security and other cash payments) and other fiscal policy spending. This appears strongest before 1980.
• Output -- There is a clear partisan effect on economic activity, with real GDP being significantly higher under Democrats than Republicans in the first half of their terms. There is no significant pre-electoral increase in aggregate economic activity, meaning there is no evidence for pre-election manipulation of the economy.
Drazen also summarizes empirical work on the second kind of research, focusing on how the performance of the economy helps to determine who wins an election. Aggregate economic conditions before an election, specifically per capita output or income growth (and to a lesser extent inflation), have a significant effect on voting patterns.
A robust finding in the political business cycle literature is the last item on the first list, stating that output tends to be higher in the first half of Democratic administrations. If this is true, then it might be expected that the stock market performs better when Democrats are in power. Evidence in favor of this hypothesis comes from this 2003 paper by Pedro Santa-Clara and Rossen Valkanov, "The Presidential Puzzle: Political Cycles and the Stock Market." In the paper, the authors look at excess returns, i.e. returns over and above the returns on Treasury bills, using data from 1927 through 1998. Their estimates show that returns are, on average, 9% higher when Democrats are in power. (See this chart of returns by political party from University of California, Berkeley professor Hal Varian's description of the paper). They note that much of the difference in returns arises from smaller firms performing much better under Democratic administrations.
Precisely why this is the case is difficult to answer. And the paper doesn't come to any strong conclusions about the driving force behind the difference in returns. Nor does it explain why the difference persists, though it does rule out a few plausible reasons for these findings. Whatever the reason for the difference in returns, the evidence suggests that returns are distinctly higher under Democratic administrations. Therefore, if you are an investor, you may want to hope for the continued reemergence of the political left and for a Democrat to win the next presidential election.
Read entire article at WSJ
In the last 30 years, a considerable amount of work has been devoted to an area of economics known as "political business cycles." Researchers in this area look at the relationship between electoral outcomes -- the outcome of elections and the economic policies of the party in power -- and the subsequent performance of the economy.
Broadly stated, there are two kinds of research on political business cycles. One type watches how the parties that win elections -- or are in control -- affect the performance of the economy. (For an overview of seminal work in this area see this paper by Allan Drazen. Also, see more recent papers here, here and here.)
The other class of research looks at the question from the opposite side. These researchers study how the performance of the economy helps decide which party wins an election. (For a good grounding in this type of work, see some important papers here and here.)
Here are some large research findings as summed up by Drazen:
• Inflation -- In the U.S., there is evidence of a post-electoral increase in inflation prior to 1979, but no evidence thereafter.
• Monetary Policy -- There is evidence of a pre-electoral increase in money growth rates from 1960 to 1980, but none thereafter. Money growth, or the percentage change in money supply, is an important measure of monetary policy prior to 1980, when the Fed started to focus on the federal-funds rate as the main monetary policy tool. There is no evidence for the U.S. of an electoral cycle in the federal-funds rate.
• Spending on Programs -- There is evidence of pre-electoral increases in government transfers (such as food stamps, Social Security and other cash payments) and other fiscal policy spending. This appears strongest before 1980.
• Output -- There is a clear partisan effect on economic activity, with real GDP being significantly higher under Democrats than Republicans in the first half of their terms. There is no significant pre-electoral increase in aggregate economic activity, meaning there is no evidence for pre-election manipulation of the economy.
Drazen also summarizes empirical work on the second kind of research, focusing on how the performance of the economy helps to determine who wins an election. Aggregate economic conditions before an election, specifically per capita output or income growth (and to a lesser extent inflation), have a significant effect on voting patterns.
A robust finding in the political business cycle literature is the last item on the first list, stating that output tends to be higher in the first half of Democratic administrations. If this is true, then it might be expected that the stock market performs better when Democrats are in power. Evidence in favor of this hypothesis comes from this 2003 paper by Pedro Santa-Clara and Rossen Valkanov, "The Presidential Puzzle: Political Cycles and the Stock Market." In the paper, the authors look at excess returns, i.e. returns over and above the returns on Treasury bills, using data from 1927 through 1998. Their estimates show that returns are, on average, 9% higher when Democrats are in power. (See this chart of returns by political party from University of California, Berkeley professor Hal Varian's description of the paper). They note that much of the difference in returns arises from smaller firms performing much better under Democratic administrations.
Precisely why this is the case is difficult to answer. And the paper doesn't come to any strong conclusions about the driving force behind the difference in returns. Nor does it explain why the difference persists, though it does rule out a few plausible reasons for these findings. Whatever the reason for the difference in returns, the evidence suggests that returns are distinctly higher under Democratic administrations. Therefore, if you are an investor, you may want to hope for the continued reemergence of the political left and for a Democrat to win the next presidential election.