Sunday, September 23, 2007

When it Comes to the Economy, It looks Like Politics as Usual

There is a theory called "the political business cycle" that posits that the party in the White House will try to get a little extra growth out of the economy in the year before the election to improve their re-election chances. Whatever they do policy wise about a year ahead of time might not be good in the longer run, after the election. But that is okay, the theory also says that voters have short memories.

So last week, when the Federal Reserve Board cut a key interest rate (the Federal Funds Rate) by half a percentage point and the stock market soared, my cynical self said, "hey, that sounds like the political business cycle I always talk about near the end of the semester in macro." The cut in interest rates will help stimulate demand. It could lead to higher inflation, but that increase could come after the election.

In the 24 years including 1981-2004, there were 6 election years. In those six election years, the average increase in real GDP (adjusted for inflation) was 4.41%. In the 18 non-election years, it was 2.74%. That may not seem like alot, but the 4.41 is actual 61% higher than 2.74 (since 4.41/2.74 = 1.61). Also notice that 4.41 - 2.74 = 1.67. So that means that if the per capita GDP were going to be, say, $40,000, it will be 1.67% more than that. And that means an extra $668. Would you sell your vote for that much?

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