Political Business Cycles in the New Keynesian Model

20 Pages Posted: 15 Sep 2010

See all articles by Fabio Milani

Fabio Milani

University of California, Irvine - Department of Economics

Abstract

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 preelection versus postelection 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 preelection quarters or not. The results provide evidence that several coefficients are influenced by political variables. The best-fitting specification, in fact, is one that allows coefficients to vary according to a regime that depends on whether the economy is in the few quarters before a presidential election or not. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. There is some evidence that policies become more expansionary before elections, but this evidence disappears for monetary policy in the post-1985 sample.

JEL Classification: C11, D72, E32, E52, E58, E63

Suggested Citation

Milani, Fabio, Political Business Cycles in the New Keynesian Model. Economic Inquiry, Vol. 48, Issue 4, pp. 896-915, October 2010, Available at SSRN: https://ssrn.com/abstract=1677118 or http://dx.doi.org/10.1111/j.1465-7295.2009.00212.x

Fabio Milani (Contact Author)

University of California, Irvine - Department of Economics ( email )

3151 Social Science Plaza
Irvine, CA 92697-5100
United States

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