The Political Cycle and the US Economy

Abstract:

In this paper we are concerned with the volatility of macroeconomic aggregates and social welfare in the U.S. economy as a result of the electoral switch in power within the two-party system. We document some stylized facts on fiscal policies for the U.S. economy and several major advanced countries, and identify political cycles in taxation and government spending. We conclude that the U.S. political friction is mostly in taxation---unlike other advanced economies. While taxes distort the allocation of investment and labor supply, we find that the political friction in taxation adds substantial volatility to the macroeconomy for a model with external debt---but not for internal debt---while the political friction in government spending adds roughly the same volatility under external and internal debt. Contrary to a common belief, the evolution of the debt stock is mostly driven by the problem of time-(in)consistency rather than by the political cycle.

Host or Publisher University of Nebraska Omaha Economics