ALBERT

Notes: Summary and conclusions We have briefly reviewed the state of the art of research on the political business cycle in the context of a simple textbook model of the macroeconomy. It has been demonstrated that the government-generated political business cycle vanishes as expectations turn rational. Even then, however, non-inflationary policies apparently are time inconsistent. Hence, democracies seem to be stuck with some sort of inflationary bias. Countries with fairly centralized wage bargaining and strong labor unions have to deal with a second political source of instability in the macroeconomy: if the labor union's program contains political items such as equal educational opportunities for working class children, extended co-determination, a more equal distribution of wealth, and the like, they will prefer to see those parties in power who show the best prospects of implementing those items. So the trade union's wage bargaining strategies take into account how bargaining results influence the state of the economy and, hence, the reelection prospects of the ruling government — and they will do so in different ways, depending on whether the union prefers the government to the opposition party or vice versa. Since this trade-union-generated or supply-side political business cycle reflects movements of the natural unemployment rate (or of the natural output level) implied by union wage policies, it does not disappear under rational expectations. It also does not seem to disappear if we consider the interaction between the trade union and the government as a Stackelberg-type game, in which the union makes the first move. This result sheds some new light on today's view of the political business cycle, in that learning on the part of the economy will eliminate the ups and downs of the real variables which governments might try to generate and, in that appropriately formulated rules will eventually remove the remaining inflationary bias. These hopes and propositions are obviously doomed to the extent that the political business cycle has its roots in the supply side of the economy. If trade unions want to and possess the power to manipulate aggregate supply in order to promote their own political interests, neither an increased rationality of expectations nor rules binding the hands of utility-maximizing governments or central banks will do any good. On the empirical side, the notion of a supply-side political business cycle may help to understand why the available evidence on the political business cycle gives a rather vague picture. On the one hand, for those believing in the rationality of expectations it may help to explain why nevertheless a number of studies have come up with positive evidence for election related cycles of economic aggregates. On the other hand, for those believing that real life typically fashions more naive forms of expectation formation which would leave vote-maximizing demand management effective, the supply-side political business cycle may help to explain why there may be no stable statistical correlation between output indicators and election dates.