“It’s the weather, stupid”

Around the world people today participate in May Day demonstrations (some call them ‘celebrations’) and in some countries it is even a public holiday. But why do people participate in May Day demonstrations? My good friend Professor Peter Kurrild-Klitgaard has the answer: It’s the weather, stupid!

Here is the abstract from Peter’s 2010 paper on the topic:

“We investigate the possible explanations of variations in aggregate levels of participation in large-scale political demonstrations. A simple public choice inspired model is applied to data derived from the annual May Day demonstrations of the Danish socialist parties and labour movement taking place in Copenhagen in the period 1980-2009. The most important explanatory variables are variation in the weather conditions. Political variables exhibit few or no robust effects and socio-economic variables none.”

Judging from the weather in Copenhagen today the annual May Day demonstrations will be well-attended (I will not be there…)

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The last brick – RIP James M. Buchanan

Nobel Prize winning economist and founding father of the Public Choice school James M. Buchanan has died at age 93. His friends and students have already offered many kind words in his memory. Here I quote two of my friends professors Steve Horwtiz and Peter Kurrild-Klitgaard.

Here is Pete:

James M. Buchanan, RIP. If making a difference is what matters, he was one of the five most influential thinkers of the last 50 years. Sharp as a knife into his 90s and always the scholar.

And Steve:

There is much that one can say about him (Buchanan), not the least of which is that he was still intellectually sharp and active into his 90s. In short: he changed the face of economics and politics and advanced the cause of liberty as much as anyone in the second half of the 20th century…

…No one who wishes to talk responsibly about politics can be ignorant of public choice theory. No one should ever invoke the language of market failure (including externalities) without having digested his work on government failure. And people who run around talking about the constitution better be able to understand something of constitutional political economy.

Beyond all of that, he was a role model of the old school scholar: widely read and properly skeptical of turning economics into an engineering discipline. He was, at bottom, a humanist and a liberal in the oldest and best senses of the terms. And best of all: he was utterly unimpressed by degrees from fancy schools.

Buchanan produced an enormous amount of scholarly works including numerous books in his long life. Best known is probably The Calculus of Consent which he co-authored with Gordon Tullock. However, the works that had the biggest influence on my own thinking undoubtedly was “What should economists do?” and “Cost and Choice”.

Even though Buchanan primarily was a constitutional economist and a Public Choice theorist he also contributed to monetary thinking. His so-called brick standard was particularly intriguing. Here is Pete Boettke and Daniel Smith on Buchanan and the brick standard:

James Buchanan, sought to bring his extensive work on rule-making to bear in envisioning a monetary regime that could operate within a contemporary democratic setting. From the start, Buchanan (1999[1962]) eschewed the ‘presuppositions of Harvey road’ that held that economic policy would be crafted and implemented by a group of benevolent and enlightened elites. Buchanan set out to make the case for a monetary regime using comparative institutional analysis that compared monetary regimes in real, not ideal settings.

Buchanan (1999[1962]) believed that it was not so much the specific type of monetary regime adopted, but the set of rules that defined that regime. Buchanan argued that the brick standard, a labor standard, or a manager confined by well-defined rules, would all put a stop to the government growth let loose by the fiscal profligacy encouraged by the wide scale acceptance of Keynesian ideas in the political realm (see Buchanan and Wagner (2000[1977]). The brick standard, as defined by Buchanan, would be a monetary regime that allowed anyone to go to the mint with a standard building brick of a specified quality and exchange it for the monetary unit, and vice versa. As the general price level fluctuated, market forces would cause automatic adjustments as people would exchange money for bricks when the price level rose above the equilibrium level, and bricks for money when the price level fell below the equilibrium level. Under this regime, market actors, guided by profits and losses would be the mechanism that achieved price predictability, not a government-entity entrusted with the goal of achieving it. In addition, a brick standard would, most likely, divorce domestic monetary policy from international balance of payment and exchange rate policies due to the fact that a brick standard would be unsuitable for those purposes.

For Buchanan (1999[1962], 417), it came down to a toss-up between a brick type standard and a limited manager. What mattered most for monetary predictability was that the rules that set up the monetary regime must be of the ‘constitutional’ variety. In other words, the rules must be set to be ‘relatively absolute absolutes’ in order to protect them from tampering.

R.I.P. James M. Buchanan

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Update – other economists and scholars on James Buchanan:

Steve Horwitz

Daniel Kuehn

Eamonn Butler

Don Boudreaux (also from Don in 2005 and Don in WSJ)

Mark D. White

Grover Cleveland

Mario Rizzo

David Boaz

Robert Higgs

David Henderson

Alex Tabarrok

Randall Holcombe

Peter Boettke

Ryan Young

Bill Woolsey

Veronique de Rugy

Nick Gillespie

Arnold Kling

Brad DeLong

Christian Bjørnskov (in Danish)

Tyler Cowen (more from Tyler Cowen)

Lenore Ealy

Garett Jones

Charles Rowley

Edward Lopez

The Economist: Free Exchange

Buchanan

Bernanke, Obama and the political business cycle – and some research ideas

This week I attended a presentation by my good friend and professor of political science at the University Copenhagen Peter Kurrild-Klitgaard about the upcoming US presidential elections. In his presentation Peter presented some of his models for predicting the outcome of US presidential elections.

Peter’s thesis is that what determines the US presidential election primarily is the economic situation in the US in the 8 quarters prior to the election. Peter’s models are inspired by Douglas Hibbs’ so-called “bread and peace” models.

If Peter is right – and I think he is – then the US president and his party will have an incentive to manipulate the business cycle to peak just prior to the elections. This is of course also is what inspired a large theoretical and empirical literature on the so-called political business cycles (PBC).

Most PBC models focus on fiscal policy. In William Nordhaus’ traditional PBC model the government would increase public spending and/or cut taxes prior to the elections and as Nordhaus assumed a traditional keynesian model of the world the government would hence be able to manipulate the business cycle.

The fact that Nordhaus assumed a rather naive keynesian model of the world obviously is also a big problem with the model and with the integration of rational expectations in macroeconomic models in 1980s and 1990s it also became increasingly clear that even though Nordhaus’ traditional PBC model is intuitively appealing it did not stand the test of time.

The biggest problem with the traditional PBC models, however, is they disregarded the importance of monetary policy. Hence, it might be that a government or a president can increase public spending prior to an election to try to get reelected, but how will the central bank react to that? Obviously if the central bank is under political control the government can just dictate to the central bank to play along and to ease monetary policy prior to the elections.

However, it is not given that the central bank is under the control of the government. In fact the central bank might even be hostile to the government and favour the opposition and in that case the central bank might actually itself be involved in manipulating the business cycle to achieve a certain political outcome which would be in contrast to what the government would like to see. In an earlier post I have described how the Bundesbank in the early 1990s punished the Helmut Kohl’s government for overly easy fiscal policy following the German reunification. This hardly helped Kohl’s government, but the Bundesbank was nonetheless unsuccessful in its indirect attempt to oust Kohl.

Did Bernanke just ensure Obama’s reelection?

During Peter’s presentation he highlighted that political prediction markets such – as the Iowa Electronic Markets – are better at predicting the outcome of US presidential elections than opinion polls. I certainly agree with Peter on this issue and therefore one of my first thoughts just after the FOMC announced it new policy action on September 13 was to think about how this influences Obama’s reelection chances.

If Peters models are right that higher real GDP growth increases the likelihood that Obama will be reelected and if I am right that I think Bernanke’s actions will likely spur real GDP growth in the short-run then the answer must be that Bernanke just helped Obama get reelected.

So what are the prediction markets saying? Well, there is no question that Obama’s election chances have increased significantly in recently. Political pundits talk about Michelle Obama’s speech at the Democrats’ convention or Romney’s not too elegant comments about Democrat voters. However, both Peter and I know that that is not really what is important. To us it is as James Carville used to say “It’s the economy, stupid”

Just have a look at the market pricing of Obama’s reelection chances – this is data from intrade.com:

I think it is pretty clear – the Federal Reserve’s actions on September 13 have helped increase the likelihood of Obama getting reelected. Whether this is good or bad is a separate matter, but it certainly illustrates that if you want to be elected president in the US you want to have fed on your side.

This is not major news – for example former Fed chairman Arthur Burn’s rather scary account  “Inside the Nixon Administration” – of his meetings with President Nixon shows that Nixon certainly was well-aware that the fed’s actions could do a lot to increase his reelection chances and that he put a lot of pressure on Burns to ease monetary policy prior to 1972 presidential elections (See my earlier post on Nixon and Burns here and Burton Abrams’ excellent discussion of the same topic here.)

This is of course also why you want to depoliticize monetary policy and get it as far away from political influence as possible – if politicians gets to control monetary policy the likelihood that they will misuse that power certainly is very high. Here the keyword is depoliticize – you in general don’t want central banks to interfere in politics for good or for bad. The central bank should just take fiscal policy as a given and respond to it only to the extent that it has an impact of it’s monetary policy target. That also includes that the central bank should not punish governments for bad policies either – as the ECB seem to be doing.

In the case of the present situation in the US it is therefore paradoxical that the Obama administration apparently has done so little to influence the decisions at the fed. So even though the Obama administration has appointed numerous Fed policy makers it does not look as if any attempt has been made to appoint Fed officials that would press for monetary easing – which obviously would have been in Obama’s interest (note this is an uneducated outsider’s guess…). This might be because the president’s main economic advisors are staunch keynesians who have little time for monetary policy matters. So if Obama is not reelected he might want to blame Larry Summers for past sins. It is equally a paradox that the fact that the Fed now seems to be moving in the direction of a more ruled based policy is what likely will help Obama get reelected.

Ideas for future research 

When I started thinking about writing this blog post I actually started out with a research idea and I want to get back to that. One of the reasons that the literature on political business cycles has not produced any general conclusions or strong empirical results is in my view that models predictions are so dependent on what assumptions are made about the institutional set-up. Is the central bank for example independent or not? Will monetary policy counteract or accommodate pre-election spending?

I therefore think that there is scope for new research on particularly central bank’s institutional structures and how that might influence the political business cycle.

In the case of the US and the Federal Reserve I think it would be very interesting to study how different FOMC member’s partisan affiliations influence their voting during the election cycle. Would for example FOMC member appointed by the president vote for easier monetary policies prior to presidential elections? And will FOMC members from certain Fed districts vote in a way favorable to the dominant political affiliation of the given fed district?

I don’t know the answers to these questions, but I think it could be a rather interesting research project…

PS Peter’s model predicts that it will be 50/50 on who wins that presidential elections. If he is right then the present market pricing which clear favours Obama is wrong. Do you trust the models of a political scientist more than the market? I am sure that Peter would be on the side of the market…

PPS I should stress that I think that Bernanke and his colleagues with its latest actions have moved closer to a rule based monetary policy, which in itself should reduce the risk of political motivated monetary policy and I in general think that it is positive. That, however, does not change the fact that that might also have helped Obama. Whether that is a positive or negative side-effect dependents on your (party) political views and I luckily don’t have to have a view on who should win the US presidential elections…

PPPS Obviously the best way to avoid political business cycles is a strongly rule based monetary policy – such as NGDP level targeting, fixed exchange rates, a gold standard or free banking…some of these options I like better than others.

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Related post – Se how the ECB also has had significant impact on Obama’s reelection changes:“Will Draghi’s LTRO get Obama reelected?”

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