Is the Political Business Cycle Really Dead?

Abstract

A decade ago in this journal, McCallum [26] proclaimed the theory of the political business cycle [30; 25; 17] to be dominated by the emergence of the rational expectations literature [23; 24; 34]. Clearly the two theories are inconsistent when a strong view of rational expectations sees governments unable to manipulate real variables to create booms in election years.' Since then new developments in macroeconomics have occasioned serious doubts as to whether the strong version of rational expectations is supported by the data [28; 2; 1; 31; 12]. Furthermore, new advances in the political business cycle literature [36; 4] have attempted to reconciliate the two theories by emphasizing that expectation errors may result from the presence of party-dependent policy reaction functions and uncertainty about election outcomes. The purpose of this paper is to step back and reconsider whether or not the empirical evidence presented by McCallum favoring rational expectations for the U.S. was really that strong and could be generalized to other countries (here, the U.K.). Given that the rational expectations hypothesis has been rejected at least in the strong McCallum and Sargent version [26; 34], it