Academic journal article International Advances in Economic Research

Politicians, Deficits, and Monetary Policy in the U.S. Revisited

Academic journal article International Advances in Economic Research

Politicians, Deficits, and Monetary Policy in the U.S. Revisited

Article excerpt

RICHARD J. CEBULA (*)

This paper reconsiders the evidence regarding the existence of executive and congressional influences on monetary policy in the U.S. Results regarding the source of the federal deficit (cyclical or structural) provide evidence that structural deficits occurring under Democratic presidential administrations have a significant impact on money growth rates, but those occurring under their Republican counterparts may not. Although the evidence regarding cyclical deficits is statistically weaker, their more limited influence on monetary growth rates appears to be similar regardless of whether they occur under Democratic or Republican presidents. This contrasts with previous research which suggests that cyclical deficits influence monetary growth rates under Democratic administrations while structural deficits generated a similar monetary response regardless of which party held the presidency. (JEL E52)

Introduction

A popular practice among economists and political scientists is to examine the hypothesis that politicians manipulate economic variables to maximize electoral support [Nordhaus, 1975; MacRae, 1977; Alesina, 1988; Nordhaus, 1989; Persson and Tabellini, 1990; Alesina and Roubini, 1990]. Indeed, Fair [1978, 1996] and Erickson [1989] demonstrate that voters reward or punish U.S. presidents based on economic conditions near elections. Thus, to accelerate GDP growth or signal his competence to the electorate, a politician might endeavor to manipulate policy instruments around election periods.

Evidence supporting the existence of political monetary cycles around U.S. presidential elections is presented by Grier [1987, 1989], whereas Beck [1987] and Alesina et al. [1992] provide mixed results. The existence of political monetary cycles would suggest that in addition to its economic mandate, the Federal Reserve (Fed) is also cognizant of presidential preferences for monetary policy. Grier and McGarrity [1998] present evidence which suggests that the electoral prospects of members of Congress are also influenced by macroeconomic conditions. Thus, they are motivated by the same electoral impulse as the president.

Additional evidence of indirect executive or legislative influence can be observed through the reaction of money supply growth to structural deficits. Structural deficits are defined as those that exist when output is at its potential level. At the potential level of output, no surplus or deficit is induced by the state of the economy (the endogenous cyclical deficit equals zero), so any existing deficit is attributable to exogenous legislative action. However, if output contracts, a cyclical deficit would arise as federal tax revenue declines along with aggregate income while federal transfer payments increase. Thus, if the economy were in a recession, the total deficit could be decomposed into its cyclical and structural components. If monetary growth rates are swayed by structural rather than cyclical deficits, this may be taken as evidence of indirect executive or legislative influence on monetary policy.

This present study reexamines the results of Grier and Nieman [1987] regarding the nature of the Fed's response to structural and cyclical deficits. In data through 1984, Grier and Nieman observe that the Fed responds uniformly to structural deficits but that cyclical deficits affect monetary growth only under Democratic presidents. By contrast, the results in this present study suggest that the opposite holds when the data set is extended through 1991.

The empirical results in this paper provide limited evidence for Grier's [1991] results that congressional preferences are reflected in monetary policy. The sensitivity of monetary growth to congressional preferences appears to vary by the aggregate used to measure money supply. The Fed appears responsive to the desires of its oversight committee in the Senate but not to its counterpart in the House of Representatives. …

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