How Much Do Election Shakeups Affect the Nation's Economy?

[swag]

Two economists, Mark Thoma of the daily must-readEconomist's View and Justin Wolfers of Wharton School knock the question around in a not terribly earthshaking, but well worth reading in its entirety, duo-post at WSJ Online's Econoblog.

Some brief excerpts:

Thoma: A robust finding in the political business cycle literature is the last item on the first list, stating that output tends to be higher in the first half of Democratic administrations. If this is true, then it might be expected that the stock market performs better when Democrats are in power. Evidence in favor of this hypothesis comes from this 2003 paper by Pedro Santa-Clara and Rossen Valkanov, "The Presidential Puzzle: Political Cycles and the Stock Market." In the paper, the authors look at excess returns, i.e. returns over and above the returns on Treasury bills, using data from 1927 through 1998. Their estimates show that returns are, on average, 9% higher when Democrats are in power. They note that much of the difference in returns arises from smaller firms performing much better under Democratic administrations.

Wolfers: There was a time when we assumed that Democrats were the "tax-and-spend" party that inherited a Keynesian philosophy, while the Republicans followed neoclassical textbooks and believed in balancing the budget. Yet the deficit rose sharply under Reagan, again under Bush (41), declined under Clinton, and is once again a real concern under the current administration. Indeed, in recent research, Erik Snowberg, Eric Zitzewitz and myself document the fact that bond yields rose sharply on news that Bush was re-elected in 2004, as typically happens when investors expect the deficit to rise. (Click here for the summary.)

Thoma (quoting fellow economist Robert Reich): "Anyone who thinks the market reacts to who's in charge of Congress or even the White House doesn't know economics and is blissfully ignorant of politics. The truth is, there's not much politicians can do to stimulate or retard the economy. Tax policies have a marginal impact, at best. Bill Clinton raised taxes and the market went up. George Bush cut taxes and the market went up. Supply-siders think tax rates are a big deal. They're wrong ... Deficits do matter because large ones can spook the market into fearing the Fed will raise interest rates to counteract the inflationary tendencies of big deficits."

Thoma (citing research by Wolfers):
Why the difference? As Justin noted earlier, "Democrats seem to care more about unemployment," and there is evidence that unemployment is lower and output growth is higher when Democrats are in power -- this is one of the regularities noted in the opening post. Bartels's explanation for the partisan differences in inequality is that "both unemployment and GDP growth have much stronger effects on income growth at the bottom of the income distribution than at the top." Thus, while the issue is not yet fully settled, this research provides strong evidence that the party in power affects the distribution of income, particularly at lower income levels.

. . . the whole read is good.