Edward Renshaw
Professor of Economics
State University of New York at Albany
Section 2A of the Federal Reserve Act as amended, requires the Board of Governors "to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates". Moreover, in carrying out monetary policy the Fed is to take "account of past and prospective developments in employment, unemployment, production, investment, real income, productivity, international trade and payments and prices".
Robert Black, President of the Federal Reserve Bank of Richmond, criticized this mandate in 1984 as being too sweeping and unrealistically general, particularly if viewed as a set of objectives to be achieved in the short run. He believes that price stability is the only sensible objective for the Fed to try to achieve with monetary policy.
In 1989 Representative Stephen Neal sponsored a congressional bill which would have required the Fed to pursue policies aimed at eliminating inflation within five years. The economic recession of 1990-91 had the effect of moth balling that idea.
In 1995, however, Senator Connie Mack of Florida introduced legislation known formally as the Economic Growth and Price Stability Act of 1995 which would make price stability the primary goal of monetary policy. This bill would require the Fed to establish an explicit numerical definition of price stability and specify a time needed to achieve stability taking into account any output and employment effects associated with the move to stability.
The Mack bill cites several reasons for making price stability the sole objective of monetary policy. It argues that inflation distorts the price mechanism, interrupting efficient allocation of resources and thereby diminishing growth and living standards. Having a single objective would reduce uncertainty about monetary policy and perhaps reduce some of the uncertainty surrounding a firm's investment.
Finally, the Mack legislation argues that making price stability the primary objective of the Federal Reserve would lead to a more stable economy. The bill's authors are of the opinion that attempts of monetary policy to stabilize the economy in the short run are often destabilizing since policy changes affect the economy with long, variable, and highly unpredictable lags.
While most of the Governors of the Federal Reserve would probably support the enactment of a Mack type bill it doesn't seem likely to happen in the near future. The U.S. electorate has a long history of being less forgiving with regard to an increase in the unemployment rate than with regard to a moderate increase in the consumer price index.
Economics, if it is a science, is the science of tradeoffs. No one has expressed this idea more colorfully than Daniel Seligman (1991): "Rule No. 1 in thinking about environmental problems is that there are no 'solutions,' only tradeoffs. We want a maximum of economic growth and a minimum of environmental damage."
The recession of 1990-91 reduced the CPI inflation rate to the lowest level in a presidential election year in over two decades and may have told us something about the nature of the electorate's willingness to sacrifice economic growth for a lower inflation rate. Is there a real tradeoff between inflation and the unemployment associated with recent recessions or are they separate problems in the minds of today's electorate?
In 1814 Broughman noted that, "A government is not supported a hundredth part so much by the constant, uniform, quiet prosperity of the country as by those damned spurts which Pitt used to have just in the nick of time." (Cited by Tufte in 1978, p. 3)
The notion that economic conditions influence voters so disturbed Nobel Laureate George Stigler in (1973) that he engaged in some econometrics to reaffirm Kramer's finding "on the electoral unimportance of ordinary fluctuations in unemployment." He then presented an argument based on rational voter behavior for "the unimportance of general economic conditions in national elections."
A more careful analysis of the historical data by Fair in (1978 and an update in 1996), however, concluded that, "Economic events as measured by the change in real economic activity in the year of the election do appear to have an important effect on votes for president. It does not matter much whether this change is measured by the growth rate of real per capita GNP or by the change in the unemployment rate, although the former gives slightly better results."
The belief that the US electorate does hold incumbent political parties accountable for their economic performance encouraged Nordhaus (1975) and MacRae (1977) to articulated theories of a political business cycle. Central to their theories is a preference function or iso-vote loss curve which reflects the willingness of the electorate to endure extra unemployment for the sake of a lower inflation rate. The authors assume that this tradeoff is predictable and can be approximated by a parabola or half circles. They also assume that the electorate is myopic and that optimum partisan policy will produce a condition of high unemployment and deflation in the early years after an election which will be followed by an inflationary boom as the next election approaches.
Keller and May (1984) have compiled some evidence which suggests that President Nixon understood the theory of the political business cycle and may have been successful at influencing monetary and fiscal policy to improve his reelection chances. Other studies, however, do not provide convincing evidence that governments have systematically manipulated economic policy in an effort to influence the outcome of presidential elections. It remains to be seen whether this will continue to be the case in the future.
When parabolas representing a non "turnover contour" curve are fit to the election year inflation and unemployment rates which encompass all those cases where the incumbent political party did not lose the presidential election, the conclusion is that the tradeoff between inflation and unemployment is not very stable. For the elections from 1920-88 Trahan and I in (1991) obtained a parabola which implies a preferred inflation rate of 1.66 percent and a maximum endurable unemployment rate of about 17.6 percent. When the parabola was fit to data for the post World War II period, however, the preferred inflation rate was 2.84 percent and the maximum endurable unemployment rate was only 9.5 percent.
Richards (1993) has examined the percentage of respondents answering "yes" to the Gallup Poll question, "Do you approve of the way President- _____is handling his job?" Using quarterly data on this variable for the period 1961:1 through 1992:3 Richards has concluded that voters consider an inflation rate equal to about three percent to be optimal in the long-run.
One of the problems with these and most other models pertaining to the possibility of a political business cycle is that they didn't do a very good job of predicting the outcome of the last presidential election.
The recessionary indicator with the best track record for predicting the outcome of presidential elections (since Woodrow Wilson was elected in 1912 with less than 42 percent of the popular vote) is changes in the unemployment rate. Hoover in 1928 represented the last political party to get reelected after an increase in the civilian unemployment rate during the last two years of a presidential term. It should be noted that the average unemployment rate was only 4.4 percent in 1928 and had been declining since shortly after the recessionary trough of November 1927. In 1929 the unemployment rate only averaged 3.2 percent in spite of an August peak in business activity.
All of the other presidential aspirants in the eighty year period from 1912-96 have been defeated if the unemployment rate wasn't reduced in the last two years before the election. This would suggest that the US electorate is somewhat myopic and must be reassured that the economy is getting better before reelecting the incumbent party. (See the changes in the unemployment rate in parentheses identified with an asterisk in column 1 of Table 10.1.)
The data in Table 10.1 are not inconsistent with the idea that the US electorate dislikes inflation, however. Since President Wilson kept the US out of World War I in 1916 no political part has been able to get reelected when the annual inflation rate for the CPI in the election year was in excess of 4.6 percent. Harding in 1920, Nixon in 1968, Carter in 1976 and Reagan in 1980 were all successful at ousting the incumbent party from the White House when the CPI inflation rates were in the 4.7 to 15.8 percent range.
Some caution should be exercised in interpreting this finding, however. Three of the four cases of high inflation in column (2) of Table 10.1 are associated with recessionary increases in unemployment in the last two years of the presidential term. The only recent case of a high inflation rate that was not associated with a recession is 1968, when George Wallace and his American Independent party split the Democratic vote and allowed Richard Nixon to defeat Hubert Humphrey with only 43.4 percent of the popular vote. Voters in many other countries have learned to live with inflation rates that are greater than 4.7 percent.
The more important risk that an incumbent political party faces in failing to control inflation is the possibility that the Fed, which dislikes inflation and has a long history of "leaning against the wind", so-to-speak, will tighten credit to the point of tipping the economy into an "ill timed" recession. In the post 1947 period there has only been one year (1977) when the Fed allowed the growth of M1 in constant dollars to increase when the CPI inflation rate was over five percent.
Since the reelection of President McKinley in 1900 no political party has been able to retain control of the White House if the economy was experiencing a recessionary decline in economic activity at the time of the election. Harding in 1920, Roosevelt in 1932 and Kennedy in 1960 all seem to have benefitted from recessions that did not end until after the election was over.)
The electorate's distaste for economic recessions appears to have increased with the passage of time. Since the election of Herbert Hoover in 1928, no president has been reelected if there was a recessionary trough in economic activity during the last two years of the presidential term. Carter in 1976, Reagan in 1980 and Clinton in 1992 all benefitted from a reluctance on the part of voters to quickly forget the most recent recession.
Another variable of concern to economists which may help to explain the outcome of presidential elections is the economic growth rate. In this century no political party has been reelected after a four-year increase in civilian employment of less than 3.5 percent. This is the only economic variable, that this analyst has discovered, which can explain the presidential turnover of 1952, when a very popular general from World War II promised to get the US out of an unpopular war.
In constructing their voter preference curves involving a tradeoff between inflation and unemployment Nordhaus and MacRae both assumed that price stability, other things equal, is preferred by the electorate to either inflation or deflation. In 1989 Alan Greenspan, indicated that he and other governors of the Federal Reserve shared this view and were willing to support a bill sponsored by Representative Stephen Neal (D-NC) which would have required the Fed to pursue polices aimed at eliminating inflation within five years.
The Fed's obsession with the problem of price stability, in any event, is not something that is fully shared by US Presidents, Congress, the electorate or even the Fed's own staff. One reason for preferring a modest inflation rate to no inflation is seignorage.
Seignorage is the revenue that governments receive from inflation when they issue currency and do not pay interest on mandated bank reserves at the Fed. Printing money can be a very rewarding business. If it only costs a dime to make a ten dollar bill the profit to the US Treasury will be 9900 percent. In 1988 the Federal Reserve acquired free and clear, at the stroke of a pen, an additional $16 billion of US government securities in the process of expanding the money supply. If it were not for seignorage governments would have to raise other taxes or borrow more money from the public.
It has been estimated that about two thirds of the more than $300 billion of US currency in circulation is circulating outside the United States. Much of this currency has been "exported" to pay for the "importation" of illegal drugs. And a sizable portion of the currency in use in the United States is also held by people who are either engaged in illegal activities or involved in underground activities that would otherwise go untaxed.
Rao Aiyagari, a research officer at the Federal Reserve Bank of Minneapolis, has suggested that the elimination of inflation might encourage more wasteful transactions that are designed to avoid taxation. He has concluded that the benefits to be expected from a zero inflation rate would be small and might even be negative (1990).
Now that the United States has ceased to be a creditor nation and has become the world's largest debtor nation there may be another good reason for not reducing the inflation rate to zero since it would burden US tax payers and make US companies less competitive in the world market place by having to pay off outstanding bonds with uninflated dollars.
Fairness is another consideration. In a world where there are differential gains in productivity and where unions in the more progressive sectors have a strong preference for obtaining their share of such gains in the form of higher wages there may be a need for some positive inflation, on the average, to fairly distribute higher income and wages to persons employed in those sectors where productivity improvements are harder to achieve. The old fashioned notion of money illusion may also have some validity, when productivity is low and unable to support an accustomed increase in wages.
It should be noted that the CPI is not a perfect measure of inflation. To the extent that consumers respond to individual price increases by switching to comparable items that cost less, it may overstate inflation. The CPI can also misrepresent inflation by not being fully adjusted for improvements in the quality of goods and services. Some studies have suggested that these factors may have caused the CPI to overstate the true inflation rate by as much as two percentage points (Kahn 1994). Hershey (1994), however, has reported that researchers at the Bureau of Labor Statistics believe that the CPI only overstates annual inflation by up to six-tenths of a percentage point. The December 1994 issue of The Monthly Labor Review is a good starting point for learning more about the various biases associated with the CPI.
The two longest recessions in the history of US business cycle analysis--the 65 month recession from October 1873 to March 1879 and the 43 month recession from August 1929 to November 1927--both followed inflation rates that were either zero or negative. The great depression of the 1930s led John Maynard Keynes to invent the notion of a liquidity trap which implies that a zero inflation rate might make it very difficult, if not impossible, for the Fed to cope with an unwanted recession.
In seven of the ten employment recessions from 1945-92 the Fed allowed the yield on new issues of 91 day Treasury bills to fall below the preceding 12 month inflation rate for the CPI for one or more months. It doesn't seem likely that this method of encouraging a revival of consumer spending would be available to policy makers if the inflation rate were zero. Why would consumers ever pay a premium for Treasury bills (which are sold at a discount since they don't pay interest) when they have the alternative of holding demand deposits that are fully insured by the federal government.
In 1969 Jan Tinbergen of the Netherlands was awarded a Nobel prize for his work in econometrics and public policy analysis. In the absence of wonder drugs which are effective against more than one disease or problem and very special interrelationships between variables which can sometimes exhibit the wonder drug property, Tinbergen was able to show that there is a need for at least as many instruments of control as there are goals or important dimensions to a problem.
The validity of this conclusion can easily be illustrated in connection with the demand and supply growth equations which were derived in Essay 8. To achieve the twin objective of a zero or stable inflation rate and a growth rate for real GDP that is equal to the economy's longer run potential growth rate one must have policy instruments that are effective at not only controlling the growth of aggregate demand but also the growth of aggregate supply.
Monetary and fiscal policy can be used in an effort to help control the growth of aggregate demand. It is less clear whether free market economies have any instruments that are very effective or efficient at ameliorating supply shocks. The dearth of acceptable instruments for controlling the growth of aggregate supply in the short run can lead to a situation where the nation's monetary authorities are confronted with conflicting objectives.
An increase in the federal funds rate, for example, might help to slow the growth of aggregate demand and lower the inflation rate but at the expense of rising unemployment and a slower growth of output. If the primary goal is to boost the growth of output, on the other hand, the funds rate should be lowered to accelerate the growth of aggregate demand but that might aggravate the problem of inflation.
One of the more interesting ways to resolve the problem of conflicting objectives is to assume that increases in the inflation rate and declines in the growth rate for real GDP are equally undesirable. Acceptance of the proposition that the goals of stable growth and inflation should be treated in a balanced way, leads one inevitably to the conclusion that the Fed should endeavor to stabilize the growth of nominal GDP which in turn will be about equal to the growth of real GDP plus the growth of its implicit price deflator.
Nobel laureate James Tobin (1980) was an early advocate of nominal GDP targeting. He noted that over short periods of time changes in nominal GDP growth give rise to similar changes in real GDP growth with relatively little impact on the inflation rate.
If one assumes that the aggregate demand curve is unit elastic the targeting of nominal GDP will be equivalent to trying to stabilize the aggregate demand growth equation which was discussed in Essay 8?. Success in this regard would mean that economic recessions and increases in the inflation rate would be entirely dependent on adverse shifts in supply.
After the Volcker inspired monetary revolution of 1979 the Board of Governors of the Federal Reserve often favored a policy of leaning against the wind in a manner that might have helped to stabilize the year to year growth rates for nominal GDP by letting short term interest rates rise when the GDP growth rate was accelerating and decline when the growth of nominal GDP was falling. See columns (4) and (5) of Table 10.2.
In 1992, during the first full year of recovery from the recession of 1990-91, however, the Fed allowed the December-December yield on the federal funds rate to decline by 1.51 percentage points in response to a .8 percentage point decline in the implicit price deflator for real GDP and one of the most anemic recoveries from an economic recession in business cycle history.
One of the more encouraging aspects to the data in Table 10.2 is that we seem to be moving in the direction of more stable and less radical changes in the growth rate for nominal GDP. From 1961-83 there were eleven years when the four quarter growth rate for nominal GDP accelerated or decelerated by more than 2.5 percentage points. Since 1983 there haven't been any years when the change in the 4th quarter to 4th quarter growth rate for nominal GDP was more than 2.5 percentage points.
One development which has changed the character of business forecasting in recent years is the discovery that a consensus prediction obtained by polling a number of different professional forecasters is cheaper and theoretically superior to the majority of forecasts. A median forecast has to be equal to or better than all forecasts if it turns out to be correct. And if it is way off the mark, the median will still be at least equal to or better than half of the forecasts.
In a world where careful evaluation of past forecasts is seldom under- taken, where much of the data is subject to revision, where models and forecasting procedures are also being revised and where better than average forecasts may have simply been the result of dumb luck, rather than a superior forecasting technique, busy decision makers are probably well advised to buy into the consensus rather than incur the expense of maintaining their own forecasting unit or purchasing the reports of many different forecasting organizations which no one has time to read.
If everyone subscribed to the consensus and no one invested any effort in trying to improve the art of forecasting, however, the value of the consensus itself would surely deteriorate and might even end up being less reliable than the sometimes hard to beat assumption that this year's growth or inflation rate will be equal to last year's preliminary four quarter growth rate.
While the flowering of consensus forecasting has reduced the need for economists, it has also opened up some new and relatively simple, yet reasonably sophisticated procedures, for quickly checking-up on the predictions of professional forecasters by polling statistical indicators rather than the people who are in the business of making forecasts.
Since the invention of electronic computers the art of economic forecasting has been heavily influenced by equations which assign a set of fixed weights to different indicators. If the tradeoffs and relationships between the various indicators were well behaved and quite stable this would be an unbeatable approach. In a world where most time series with leading indicator properties are rather volatile and where economic and financial innovation, bad weather, fits of speculative enthusiasm and political disturbances can distort statistical relationships, however, it will sometimes be better to examine pertinent indicators on an individual basis and simply count the number of indicators that seem to be pointing in a particular direction. Disturbances that are peculiar to one or just a few of the relevant indicators will drop by the wayside and not distort the entire forecast.
In some cases there may be a dominantly superior indicator. There are many situations, however, where one is more likely to be right about the future if a majority of the more reliable indicators are pointing in the same direction.
One of the advantages in polling the indicators is that it does allow one to focus on a very specific objective such as the identification of a peak in business activity before it occurs. In pursuing such a narrow objective it may be possible to use some indicators that are too volatile, specialized or otherwise misbehaved to be included in a composite index of leading indicators or a general purpose forecasting model.
Interest rates, for example, are generally classified as being a lagging indicator but show some promise of being a useful predictor of business peaks if they increase at a very rapid rate or rise to too high a level in relation to previous lows (Essay 3).
In a presentation before the House Banking Committee on February 6, 1975, Chairman Burns noted that the Board of Governors and its open market committee do pay close attention to monetary aggregates but do not confine their attention to one particular definition of the money supply, namely demand deposits plus currency outside banks: "The reason is that this concept no longer captures adequately the forms in which liquid balances--or even just transaction balances--are currently held. Financial technology in our country has been changing rapidly. Corporate treasurers have learned how to get along with a minimum of demand deposits, and to achieve the liquidity they need by acquiring interest-earning assets. For the public at large, saving deposits at commercial banks, shares in savings and loan associations, certificates of deposit, Treasury bills and other liquid instruments have become very close substitutes for demand deposits".
In the same year (1975) this analyst examined the three most common definitions of the money supply (at that time) and found that they were all of some value in forecasting nominal GNP. Even better predictions were obtained, however, by selecting a median forecast rather than by narrowing the forecasting process down to the one monetary aggregate with the best forecasting record.
While financial innovations have distorted the growth rates for the more conventional monetary aggregates and led the Board of Governors to downgrade them as reliable indicators of what might happen to the economy it might still be a mistake to ignore their behavior altogether.
The monetary aggregate that is most overlooked in the search for a stable demand for money is cash. The data in Table 10.3 would strongly suggest, however, that currency should not be overlooked when the quantity theory of money is used for forecasting purposes.
In macroeconomic modeling and forecasting it has become standard practice to include the lagged dependent variable in most structural equations. In keeping with this tradition we have calculated error terms for a following year consensus forecast of the year-year growth rate for nominal GDP based on its own preceding four quarter growth rate and Dec.- Dec. growth rates for currency and M2.
The median consensus forecasts, which are identified with a double asterisk in Table 10.3, have a mean absolute error (MAE) of only 1.16 percentage points for the 1960-95 period. This can be contrasted to MAE's of 2.25 percentage points for currency by itself, 1.97 percentage points for M2 and 1.56 percentage points for the preceding four quarter growth rate for nominal GDP. For the 16 cases where the median forecast is associated with the growth rate for currency or M2 the MAE is only .97 percentage points.
In the last column of Table 10.3 error terms are shown for a more robust consensus that is obtained by simply averaging the growth rates for currency, M2 and the four quarter growth rate for nominal GDP. The MAE for this type of consensus forecast is only 1.07 percentage points. Since 1991 the error terms have been consistently under one percentage point--something that has never happened before for more than three years in a row.
For the 1962-87 period the MAE for the President's Council of Economic Adviser's forecasts of nominal GDP was 1.2 percentage points (McNees, 1988). During the same period the MAE for the error terms in column (5) of Table 10.3 was only about 1.1 percentage points.
The consensus forecasts are lower, on the average, when the percentage point spread between the highest and lowest growth rates for currency, M2 and the 4 quarter growth rate for nominal GDP is small. For the 13 resolved cases where the spread is equal to 3.3 percentage points or less the mean absolute error for the consensus forecast in the last column of Table 10.3 is only .95 percentage points.
This result is noteworthy since the indicator spreads of 1.4 percentage points for both 1995 and 1996 are tied for the distinction of being the third lowest spreads in the 1960-96 period as a whole. The implication is that the growth rates for currency and M2 may now be more closely in tune with what is likely to happen to nominal GDP than ever before.
In its February 1997 report to Congress, the President's Council of Economic Advisers estimated that nominal GDP will increase by about 4.6 percent during 1997. This forecast is the same as the 4.6 percent growth rate for M2 during 1996. The consensus forecasts in Table 10.3, however, are forecasting a somewhat higher growth rate in the 5.2-5.3 percent range.
Another interesting question to be raised in connection with the consensus forecasts is why have the growth rates for currency and M2 behaved in such a "complementary" manner?
In the early 1990s, when the Fed began to persistently lower short term interest rates in response to a slow recovery from the recession of 1990-91, many investors shifted savings out of small denomination time deposits (which are a component of M2) into the stock and long term bond markets. The implementation of fixed charges on cash withdrawals from ATMs and the lowest rates of return on savings accounts in about 30 years may have encouraged some consumers to hold more currency.
After the Fed launched its preemptive strike against the possibility of accelerating inflation in 1994 the Dec.-Dec. growth rate for currency plunged downward and the growth rate for M2 recovered to more normal levels. Whether these two growth rates will continue to behave in an off-setting manner is one of the more interesting questions to be answered with the passage of time.
In a now classic article on "Stability In Competition," Harold Hotelling developed a theory of duopoly which has been appropriated by professors concerned with public choice to help explain the behavior of a two party political system. If voters preferences with regard to a possible tradeoff between inflation and unemployment are spread out along a locational continuum there will be a tendency on the part of both political parties to converge to the center and reflect the preferences of the median voter. Drawing on the median as against quartile solutions, Hotelling suggests that the platforms of the Republican and Democratic parties will be similar and to cite his colorful expression, "Our cites become uneconomically large and the business districts within them are too concentrated. Methodist and Presbyterian churches are too much alike; cider is too homogeneous."
The difficulties that are encountered in maintaining a political constituency, however, may lead to macroeconomic policies that are more differentiated than one might expect on the basis of Hotelling's duopoly model.
Some economists, such as Alesina (1988) and Mankiw, have noted a remarkable propensity for the real GNP growth rate to accelerate during the second year of a Democratic administration and to decline during the second year of a Republican administration. They believe that the two parties may have different preferences and policies regarding inflation and unemployment. Republicans seem to dislike inflation more than Democrats and may be more willing to endure a recession soon after coming into office in order to reduce inflation. Some additional support for this assessment is provided in Table 10.4. From 1948-94 the unemployment rate was reduced by half a percentage point or more during the second year of a Democratic administration and was usually allowed to increase during a Republican administration.
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Presidential Civilian CPI Change Civilian President Elec.
Election Unemployment Inflation Misery Employment and Political
Year Rate Rate Index Increase Affiliation
Cases Where the Incumbent Political Party Was Re-elected
(1)n (2)n (3)n (4)n (5)
1916 4.8(-3.2) 7.4* --- 6.1 Wilson (D)
1924* 5.5(-2.1) .3 -14.0 7.2 Coolidge (R)
1928 4.4( 2.5)* - 1.2 - 2.6 7.3 Hoover (R)
1936 16.9(-4.8) 1.0 4.5* 15.6 Roosevelt (D)
1940 14.6(-4.4) .8 - 2.5 8.0 Roosevelt (D)
1944 1.2(-3.5) 1.6 -12.6 13.6 Roosevelt (D)
1948 4.0(- .5) 2.7 3.9* 10.0 Truman (D)
1956 4.2(- .8) 2.9 3.5* 5.9 Eisenhower (R)
1964 5.0(- .5) 1.2 - 1.9 5.4 Johnson (D)
1972 5.2(- .9) 3.4 .5* 8.2 Nixon (R)
1984 7.2(-3.6) 4.0 - 8.5 5.7 Reagan (R)
1988 5.3(-1.3) 4.4 - 1.5 9.5 Bush (R)
1996 5.3(- .1) 3.3 -1.6 6.9 Clinton (D)
Cases Where the President Was Elected From an Opposing Party
1920 4.0( 2.6)* 15.8* 7.6* 3.1* Harding (R)
1932 23.6(14.9)* -10.2 10.2* -15.7* Roosevelt (D)
1952 2.7(-1.6) .9 - 3.1 3.3* Eisenhower (R)
1960 6.6( .4)* 1.5 1.0* 3.1* Kennedy (D)
1968* 3.4(- .4) 4.7* 1.9* 9.5 Nixon (R)
1976 7.8( .6)* 4.8* 4.0* 8.0 Carter (D)
1980 7.3( 1.3)* 12.4* 7.1* 11.9 Reagan (R)
1992* 7.3( 1.2)* 2.9 .5* 2.3* Clinton (D)
Footnotes for Table 10.1
(1)n. Average rate for the years 1916-44 and the December rate for the years 1948-92. The figures in parentheses are the changes in the unemployment rate during the last two years or 24 months of the presidential term. An increase in the unemployment rate is used to predict an election turnover.
(2)n. Average annual rates 1916-44 and annual rates 1948-92. An inflation rate in excess of 4.5 percent is used to predict an election turnover.
(3)n. The misery index is equal to the sum of the unemployment and inflation rates in columns (1) and (2). The change in the misery index is from one presidential election year to the next. An increase in the index is used to predict an election turnover. The all item CPI has not been extended back to 1912. From 1911-12, however, the Bureau of Labor Statistic's food at home only index increased 6 percent. This would suggest that there may not have been an increase in the misery index from 1912-16.
(4)n. Thousands of employed civilians 14 years and older 1912-48 and employed persons 16 and over 1948-92. A four year percentage increase in civilian employment of less than 3.5 percent is used to predict an election turnover.
*Cases where a presidential election turnover is predicted. The asterisks associated with 1924, 1968 and 1992 represent years of electoral unhappiness when third party candidates were able to corral ten percent or more of the popular vote for president. Since James Buchanan was able to get the Democratic party reelected in 1856 with only 45.3 percent of the popular vote, the incumbent political party has usually lost the election after this strong a showing on the part of third party candidates. The only exception is Calvin Coolidge in 1924 when there were no economic variables pointing in the direction of a presidential turnover. Lincoln in 1860, Cleveland in 1892, Wilson in 1912, Nixon in 1968 and Clinton in 1992 may have all been the beneficiaries of third party candidates who split the incumbent party vote and allowed themselves to win with only 39.8 to 46.1 percent of the popular vote. In 1968 George Wallace, running as a third party candidate split the democratic vote and allowed Richard Nixon to defeat Hubert Humphrey with only 43.4 percent of the popular vote. In 1992 Ross Perot ran as a third party candidate and allowed Bill Clinton to defeat George Bush with only 43 percent of the popular vote. In 1980 an independent candidate by the name of John Anderson was able to capture 6.6 percent of the popular vote. We have ignored this marginal case in assigning asterisks to the outcome of presidential elections on the grounds that Reagan was able to capture 50.7 percent of the popular vote and that there were enough economic variables pointing in the direction of a turnover so that Carter might have lost the election anyway.
4 Quarter Growth Rates First Difference
Year December ---------------------- --------------------------
Fed Funds IPD Real Nominal Nominal Funds IPD Real
Rate GDP GDP GDP Rate GDP
(1) (2) (3) (4) (5) (6)
1960 1.98 1.7 2.0 --- --- ---
1961 2.33 .4 7.4 5.4 .35 -1.3
1962 2.93 1.7 5.4 -2.0# .60 1.3
1963 3.38 1.2 6.7 1.3 .45 -.5#
1964 3.85 1.6 6.7 .0 .47** .4
1965 4.32 2.0 10.8 4.1 .47 .4
1966 5.40 3.6 7.9 -2.9# 1.08 1.6
1967 4.51 3.4 6.0 -1.9 -.89 -.2
1968 6.02 4.4 9.5 3.5 1.51 1.0
1969 8.97 5.0 6.9 -2.6# 2.95 .6
1970 4.90 5.1 5.0 -1.9 -4.07* .1#
1971 4.14 5.1 9.4 4.4# -.76 .0
1972 5.33 4.3 11.9 2.5 1.19 -.8#
1973 9.95 7.0 11.4 -.5# 4.62** 2.7
1974 8.53 10.1 8.0 -3.4 -1.42 3.1#
1975 5.20 7.7 10.3 2.3# -3.33 -2.4
1976 4.65 5.3 10.0 -.3 -.55* -2.4
1977 6.56 6.4 11.7 1.7 1.91* 1.1
1978 10.03 8.2 14.8 3.1 3.47* 1.8
1979 13.87 8.6 9.9 -4.9# 3.84** .4
1980 18.90 9.8 9.9 .0 5.03 1.2
1981 12.37 8.3 9.4 -.5 -6.53* -1.5
1982 8.95 5.2 3.5 -5.9 -3.42 -3.1
1983 9.47 3.9 11.2 7.7 .52 -1.3#
1984 8.38 3.6 9.0 -2.2 -1.09 -.3
1985 8.27 3.4 7.3 -1.7 -.11 -.2
1986 6.91 2.5 5.0 -2.3 -1.36 -.9
1987 6.77 3.3 7.4 2.4# -.14 .8#
1988 8.76 4.0 7.6 .2 1.99* .7
1989 8.45 3.9 6.4 -1.2 -.31 -.1
1990 7.31 4.6 4.4 -2.0 -1.14 .7#
1991 4.43 3.4 3.8 - .6 -2.88* -1.2
1992 2.92 2.6 6.3 2.5# -1.51 -.8
1993 2.96 2.5 4.7 -1.6# .04 -.1#
1994 5.45 2.3 5.9 1.2 2.49* -.2#
1995 5.60 2.5 3.8 -2.1# .15 .2
1996 5.29 1.8 5.2 1.4# -.31 -.7
Footnote for Table 10.2
#Identifies years when the first differences in the 4th quarter to 4th quarter growth rates for nominal GDP in column (4) or the implicit price deflator for real GDP in column (6) moved in opposite directions from the December to December change in the average monthly yield for the federal funds rate in column (5).
*Identifies cases where the change in the federal funds yield in column (5) moved in the same direction as the change in the nominal GDP growth rate in column (4) but was greater absolutely than the change in the nominal GDP growth rate. The associated changes in nominal GDP have tended to be smaller when the Fed pursued such a vigorous policy of leaning against changes in the GDP growth rate.
**Idenfifies cases where a relatively vigorous policy of leaning against an acceleration in the inflation rate for the implicit price deflator in column (6) turned out to be successful at slowing the growth rate for nominal GDP in column (4).
Growth Rates and Forecasting Errors
Year ---------------------------------------- Following Year Mean
Currency M2 4 Quarter GDP Nominal GDP Error
(1) (2) (3) (4) (5)
1960 -.3( 3.8) 4.9(-1.4) 2.0( 1.5)** 3.5(- .3)# ( 1.5)
1961 2.1( 5.3) 7.4( .0)** 7.4( .0)** 7.4( 3.9) ( .8)
1962 3.4( 2.1) 8.1(-2.6) 5.4( .1)** 5.5(-1.9) (- .1)
1963 6.3( 1.1) 8.4(-1.0) 6.7( .7)** 7.4( 1.9) ( .3)
1964 5.3( 3.2) 8.0( .5) 6.7( 1.8)** 8.5( 1.1)# ( 1.8)
1965 6.2( 3.3) 8.1( 1.4)** 10.8(-1.3) 9.5( 1.0)# ( 1.1)
1966 5.6( .2)** 4.6( 1.2) 7.9(-2.3) 5.8(-3.7) (- .2)
1067 5.3( 3.9) 9.3(- .1) 6.0( 3.2)** 9.2( 3.4) ( 2.3)
1968 7.5( .4) 8.0(- .1)** 9.5(-1.6) 7.9(-1.3) (- .4)
1969 6.3(- .9)** 3.7( 1.7) 6.9(-1.5) 5.4(-2.5) (- .2)
1970 6.3( 2.4)** 6.6( 2.1) 5.0( 3.7) 8.7( 3.3) ( 2.7)
1971 7.0( 2.9) 13.4(-3.5) 9.4( .5)** 9.9( 1.2) ( .0)
1972 8.1( 3.6) 13.0(-1.3) 11.9(- .2)** 11.7( 1.8) ( .7)
1973 8.2( .1)** 6.6( 1.7) 11.4(-3.1) 8.3( 3.4) (- .4)
1974 10.2(-1.3) 5.5( 3.4) 8.0( .9)** 8.9( .6)# ( 1.0)
1975 8.7( 2.8) 12.7(-1.2) 10.3( 1.2)** 11.5( 2.6) ( .9)
1976 9.2( 2.2) 13.3(-1.9) 10.0( 1.4)** 11.4(- .1)# ( .6)
1977 9.9( 3.1) 10.3( 2.7)** 11.7( 1.3) 13.0( 1.6)# ( 2.4)
1978 9.8( 1.8)** 7.6( 4.0) 14.8(-3.2) 11.6(-1.4)# ( .9)
1979 9.2(- .3)** 7.9( 1.0) 9.9(-1.0) 8.9(-2.7) (- .1)
1980 10.1( 1.8) 8.5( 3.4) 9.9( 2.0)** 11.9( 3.0) ( 2.4)
1981 6.2(-2.1) 9.7(-5.6) 9.4(-5.3)** 4.1(-7.8) (-4.3)
1982 8.1( .3)** 8.8(- .4) 3.5( 4.9) 8.4( 4.3) ( 1.6)
1983 10.3( .7) 11.4(- .4) 11.2(- .2)** 11.0( 2.6) ( .0)
1984 6.8( .3) 8.7(-1.6)** 9.0(-1.9) 7.1(-3.9) (-1.1)
1985 7.6(-1.8)** 8.0(-2.2) 7.3(-1.5) 5.8(-1.3)# (-1.8)
1986 7.6(-1.5)** 9.5(-3.4) 5.0( 1.1) 6.1( .3)# (-1.3)
1987 8.9(-1.3) 3.6( 4.0) 7.4( .2)** 7.6( 1.5) ( 1.0)
1988 7.8(- .1) 5.8( 1.9) 7.6( .1)** 7.7( .1) ( .6)
1989 4.9( .7) 5.5( .1)** 6.4(- .8) 5.6(-2.1) ( .0)
1990 10.9(-7.9) 3.7(- .7) 4.4(-1.4)** 3.0(-2.6) (-3.3)
1991 8.3(-2.8) 3.1( 2.4) 3.8( 1.7)** 5.5( 2.5) ( .4)
1992 9.5(-4.6) 1.6( 3.3) 6.3(-1.4)** 4.9(- .6)# (- .9)
1993 10.0(-4.2) 1.6( 4.2) 4.8( 1.0)** 5.8( .9)# ( .3)
1994 10.1(-5.5) .4( 4.2) 5.9(-1.3)** 4.6(-1.3) (- .9)
1995 5.2(- .7) 4.2( .3)** 3.8( .7) 4.5(- .1)# ( .1)
1996 6.0( ) 4.6( ) 5.2( )** ?
------------------Mean Absolute Error------------------------------
1960-95 2.25 1.97 1.56 2.07 1.07
Footnotes for Table 10.3
The forecasts in this table are based on the Dec.-Dec growth rates for currency in column (1), the Dec.-Dec. growth rate for M2 in column (2) and 4th quarter to 4th quarter growth rates for nominal GDP in column (4). The figures in parentheses are the actual following year growth rates for nominal GDP in column (4) minus the predicted growth rates.
The error terms in column (4) assume that next year's growth rate for nominal GDP will be equal to this year's growth rate. The # mark identifies cases where these error terms were smaller than the **consensus forecasts for the three prediction indicators. The forecast for 1997 is based on preliminary information released in early February.
**The median growth rate and error term for the prediction variables in the first three columns. The mean absolute error for this type of consensus forecast was 1.16 percentage points for the 1960-95 period.
The error terms in column (5) are based on the mean growth rates for currency, M2 and the 4 quarter growth rate for nominal GDP.
Democratic Administrations
--------------Year of Term----------------
President First Second Third Fourth
Truman 2.1 - .6 -2.0 - .3
Kennedy/Johnson 1.2 -1.2 .2 - .5
Johnson - .7 - .7 .0 - .2
Carter - .6 -1.0 - .3 1.3
Clinton - .6 - .7 - .5 - .2
Republican Administrations
Eisenhower I - .1 2.6 -1.1 - .3
Eisenhower II .2 2.5 -1.3 .0
Nixon - .1 1.4 1.0 - .3
Nixon/Ford - .7 .7 2.9 - .8
Reagan I .5 2.1 - .1 -2.1
Reagan II - .3 - .2 - .8 - .7
Bush - .2 .2 1.2 .7
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