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Political Business Cycles in the New Keynesian Model

  • Fabio Milani

    ()

    (Department of Economics, University of California-Irvine)

This paper tests various Political Business Cycle theories in a New Keynesian model with a monetary and fiscal policy mix. All the policy coefficients, the target levels of inflation and the budget deficit, the firms' frequency of price setting, and the standard deviations of the structural shocks are allowed to depend on 'political' regimes: a pre-election vs. post-election regime, a regime that depends on whether the President (or the Fed Chairman) is a Democrat or a Republican, and a regime under which the President and the Fed Chairman share party affiliation in pre-election quarters or not. The model is estimated using full-information Bayesian methods. The assumption of rational expectations is relaxed: economic agents can learn about the effect of political variables over time. The results provide evidence that several coefficients depend on political variables. The best-fitting specification is one that allows coefficients to depend on a pre-election vs. non-election regime. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. The results overall support the view of an independent Fed that avoids taking policy decisions right before elections. There is some evidence, however, that policies become more expansionary before elections, but this evidence seems to disappear in the post-1985 sample. The estimates also indicate that firms similarly delay their price-setting decisions until after the upcoming Presidential election.

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File URL: http://www.economics.uci.edu/files/docs/workingpapers/2007-08/Milani-05.pdf
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Paper provided by University of California-Irvine, Department of Economics in its series Working Papers with number 070805.

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Length: 37 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:irv:wpaper:070805
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Web page: http://www.economics.uci.edu/

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  1. repec:cup:macdyn:v:9:y:2005:i:1:p:1-27 is not listed on IDEAS
  2. Burton A. Abrams, 2006. "How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes," Working Papers 06-04, University of Delaware, Department of Economics.
  3. Alesina, Alberto F & Cohen, Gerald D & Roubini, Nouriel, 1992. "Macroeconomic Policy and Elections in OECD Democracies," CEPR Discussion Papers 608, C.E.P.R. Discussion Papers.
  4. Abrams, Burton A & Butkiewicz, James L, 1995. " The Influence of State-Level Economic Conditions on the 1992 U.S. Presidential Election," Public Choice, Springer, vol. 85(1-2), pages 1-10, October.
  5. Adam, Klaus, 2003. "Learning to Forecast and Cyclical Behavior of Output and Inflation," CFS Working Paper Series 2003/01, Center for Financial Studies (CFS).
  6. Sungbae An & Frank Schorfheide, 2007. "Bayesian Analysis of DSGE Models," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 113-172.
  7. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-party System as a Repeated Game," Scholarly Articles 4552531, Harvard University Department of Economics.
  8. Burton Abrams & Plamen Iossifov, 2006. "Does the Fed Contribute to a Political Business Cycle?," Public Choice, Springer, vol. 129(3), pages 249-262, December.
  9. Alberto Alesina & Gerald D. Cohen & Nouriel Roubini, 1992. "Macroeconomic Policy And Elections In Oecd Democracies," Economics and Politics, Wiley Blackwell, vol. 4(1), pages 1-30, 03.
  10. Cohen, Gerald & Alesina, Alberto & Roubini, Nouriel, 1992. "Macroeconomic Policy and Elections in OECD Democracies," Scholarly Articles 4553023, Harvard University Department of Economics.
  11. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-Party System as a Repeated Game," The Quarterly Journal of Economics, MIT Press, vol. 102(3), pages 651-78, August.
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