By Raphaelle Gauvin-Coulombe, Queen’s University

Fiscal policy in response to the Great Recession of 2008-09 varied widely across OECD countries. The United States, for example, took an expansionary fiscal stance, adopting an important stimulus package in February 2009 on the order $787 billion (CBO estimate). Canada’s response went in the same direction with its Economic Action Plan, a $30 billion stimulus package enacted in January 2009 (Department of Finance, Canada). Alternatively, on the other side of the Atlantic, policy-makers in the United Kingdom, Germany, and elsewhere either proposed, or implemented, austerity measures. The effectiveness of these different responses is still debated among economists and policy-makers today, and the political drivers of such heterogeneity are still imperfectly understood.

The wide range in fiscal responses to the global financial crisis raises an important issue about the factors driving the stance of fiscal policy. On one hand, one could argue that differences in a country’s fiscal stance may be partly driven by differences in the political orientation of the government. On the other hand, the multi-year debt crisis coincided with a noticeable move towards right-wing governments in many European countries – Greece, Italy, the United Kingdom, Portugal, Finland, and Ireland, for example – suggesting that government ideology is in turn contingent on the state of the economy.  

In a recent working paper entitled “Fiscal Policy, Government Ideology, and Economic Activity: Evidence from OECD Countries”, I investigate empirically the dynamic interaction between the political orientation of governments, macroeconomic policies, and economic activity. I study the group of OECD countries over the 1946–2015 period in an environment where electoral and economic outcomes are jointly determined. Using a panel structural vector-autoregression (VAR) and a rich dataset from the Manifesto Research Group (MRG) that contains time-varying ideological party positions in most OECD countries from the post-WWII era, I explore how the domestic political environment affects policy output and consequently business cycles. I then investigate the political impacts of those business cycles – specifically, if the support for left- vs right-wing parties is influenced by the state of the economy.

I find that the key channel through which the political orientation of governments affects economic activity is via government spending. In particular, I find that the election of a left-wing government or a left-wing ruling coalition is followed by higher government spending growth in the following year, which in turn leads to a temporary increase in GDP growth. The result that ideological differences have no apparent direct impact on output growth other than through their impact on fiscal policy contradicts the “confidence” hypothesis predicting that austerity announcements are expansionary through the rise in consumer and business confidence. As well, this finding suggests that the ability to implement efficient economic policy does not vary across ideological groups. I also consider other macroeconomic policies, such as monetary policy, are considered, finding that since the mid 1990s, monetary policy has been independent of the executive branch.

I find that another key political determinant of government spending is the timing of elections, an idea initially formalized by Nordhaus (1975) and Lindbeck (1976) in the development of the “opportunistic model”. In particular, I find that both left- and right-wing parties appear to spend more in the year preceding the election. These results hold when looking at different samples of countries, such as the old and the new democracies as well as the countries with fixed and flexible election dates. Overall, these findings highlight the importance of considering the domestic political environment for understanding both the causes and consequences of economic policy.   

References

Lindbeck, A. (1976). Stabilization policy in open economies with endogenous politicians. The American Economic Review, 66(2):1–19.

Nordhaus, W. (1975). The political business cycle. Review of Economic Studies, 42(2):169– 190.

Volkens, A., Lehmann, P., Matthieß, T., Merz, N., Regel, S., and Werner, A. (Version 2016b). The manifesto data collection. Manifesto Project (MRG/CMP/MARPOR).

Fiscal Policy photo by Nick Youngson CC BY-SA 3.0 Alpha Stock Images