Testing for the Strong Form of Rational Expectations with Heterogeneously Informed Agents

In recent years, political scientists have tested for the existenceof rational expectations (RE) using survey-based aggregate dataon subjective economic perceptions. These tests suffer fromseveral conceptual shortcomings of a nontrivial nature. In thisstudy, the meaning of RE is clarified, and also a test for strongrational expectations (SRE) where citizens possess heterogeneousinformation levels is set forth. These empirical tests provideinsights into what kinds of information citizens use in formingexpectations from that which they do not utilize but could employto arrive at more accurate forecasts. Using inflation expectationsdata for the period January 1978–December 1993, the empiricalfindings indicate that citizens can benefit from greater relianceon objective economic and political conditions when formulatingtheir inflation expectations. The broader implications of thiswork pertain not only to the execution of RE tests in politicalscience, but also to distinguishing which types of informationpeople do and do not (but could) incorporate in their decision-makingcalculus.     

Elite economic forecasts,economic news,mass economic expectations,and voting intentions in Great Britain

Abstract In order to test the notion that the electorate relies, derivatively, on professional economic forecasts, we consider the entire chain between elite economic expectations, economic news, mass economic expectations, and voter preferences. We find that while elite expectations are based on the objective economy, they are politically biased in the neighborhood of elections. Reports of economic news, while based on the objective economy and on elite expectations, have their own political rhythm in the form of election–related cycles. The pattern in news coverage, in turn, is mirrored by election–related cycles in personal and general expectations formed by the mass public. While the relevance of each of the linkages from elite expectations to news coverage to mass expectations is thus confirmed, our findings challenge the view that the link between mass expectations and voting intentions can be attributed mainly to the dissemination of elite forecasts to the general public. We conclude by discussing the implications of our findings for an understanding of the ability and functioning of mass electorates.     

Elite economic forecasts, economic news, mass economic expectations, and voting intentions in great britain

In order to test the notion that the electorate relies, derivatively, on professional economic forecasts, we consider the entire chain between elite economic expectations, economic news, mass economic expectations, and voter preferences. We find that while elite expectations are based on the objective economy, they are politically biased in the neighborhood of elections. Reports of economic news, while based on the objective economy and on elite expectations, have their own political rhythm in the form of election–related cycles. The pattern in news coverage, in turn, is mirrored by election–related cycles in personal and general expectations formed by the mass public. While the relevance of each of the linkages from elite expectations to news coverage to mass expectations is thus confirmed, our findings challenge the view that the link between mass expectations and voting intentions can be attributed mainly to the dissemination of elite forecasts to the general public. We conclude by discussing the implications of our findings for an understanding of the ability and functioning of mass electorates.     

The political economy of IMF forecasts

We investigate the political economy of IMF forecasts with data for 157 countries (1999–2005). Generally, we find evidence of forecast bias in growth and inflation. Specifically, we find that countries voting with the United States in the UN General Assembly receive lower inflation forecasts as domestic elections approach. Countries with large loans outstanding from the IMF also receive lower inflation forecasts, suggesting that the IMF engages in “defensive forecasting.” Finally, countries with fixed exchange rate regimes receive lower inflation forecasts, suggesting the IMF desires to preserve stability as inflation can have detrimental effects under such an exchange rate regime.     

Inflation,recession and the federal budget deficit (or,blaming economic problems on a statistical mirage)

Policy proposals to balance the budget and to limit government spending assume that budget deficits cause substantial harm, either increasing inflation or crowding out private borrowing from credit markets. These assertions have the support of policymakers across the breadth of the political spectrum, and dominate current political debate on macroeconomic policy. However, macroeconomic theory fails to provide a clearcut causal connection between budget deficits and larger economic problems such as inflation and recession. Thus, policies could be enacted that attack the symptoms instead of the causes of the deficit.We use the Granger causality test to find the causal relationships between budget deficits and inflation, GNP, and private investment respectively, for seventeen OECD countries for the period 1949–1981. Deficits do not cause changes in these variables; rather there is weak evidence that inflation and recession cause deficits. This implies that deficits are a symptom rather than a cause of inflation and reduced national output. So, if our goal is to reduce inflation and increase output, we should look to more direct policies than reducing deficits.An earlier version of this article was presented at the Annual Meeting of the American Society for Public Administration, New York, April 16–19, 1983.     

Multi-dimensional economic voting in Spain: The 2008 election

Economic voting studies remain contentious in Spain. The notion is widely-held that there is no economic vote in that country, due to the pervasive and effacing influences of left-right ideology. Still, a growing number of investigations show a significant impact of economic evaluation on the vote choice in Spanish national elections. At least one possible exception here is the 2008 election, where the question has received no systematic treatment. In this study, we explore the impact of economic voting in that contest. We find, first, the presence of strong economic voting of the valence kind. Second, we find that two hitherto unstudied dimensions of economic voting – position and patrimony – have their own independent effect.     

Forecast dispersion,dissenting votes,and monetary policy preferences of FOMC members: the role of individual career characteristics and political aspects

Using data from 1992 to 2001, we study the impact of members’ economic forecasts on the probability of casting dissenting votes in the Federal Open Market Committee (FOMC). Employing standard ordered probit techniques, we find that higher individual inflation and real GDP growth forecasts (relative to the committee’s median) significantly increase the probability of dissenting in favor of tighter monetary policy, whereas higher individual unemployment rate forecasts significantly decrease it. Using interaction models, we find that FOMC members with longer careers in government, industry, academia, non-governmental organizations (NGOs), or on the staff of the Board of Governors are more focused on output stabilization, while FOMC members with longer careers in the financial sector or on the staffs of regional Federal Reserve Banks are more focused on inflation stabilization. We also find evidence that politics matters, with Republican appointees being much more focused on inflation stabilization than Democratic appointees. Moreover, during the entire Clinton administration ‘natural’ monetary policy preferences of Bank presidents and Board members for inflation and output stabilization were more pronounced than under periods covering the administrations of both George H.W. Bush and George W. Bush, respectively.     

Who should be chef? The dynamics of valence evaluations across income groups during economic crises

In this paper, we investigate partisan rationalization in valence politics by trying to better specify the direct and indirect effects of the economy on government support. To do so, we examine how income levels moderate the influence of objective economic conditions on perceptions of which party is the best manager of the economy during a period of economic crisis, 2004–2010, in the United Kingdom. We find that low-income voters are more responsive in their assessments of the incumbent Labour government based on unemployment, as are high-income voters in terms of inflation. In addition, high-income voters tend to behave in a manner consistent with partisan rationalization, while low-income voters do not. These conclusions offer important implications for the effectiveness of electoral control of government policy, as well as the quality of representation.     

How do established voters react to new parties? The case of Italy, 1985–2008

The Italian party system largely collapsed in the early 1990s, providing us with a natural experimental situation in which voters were confronted with new parties – indeed, with an entirely new party system. How did they react? This paper develops a number of expectations on the basis of existing theory and tests these expectations using a dataset consisting of election studies conducted in Italy between 1985 and 2008. We find that a new party system causes confusion as to where parties stand in left-right terms, making it difficult for voters to make their choices on the basis of ideological cues. The confusion is greatest among older voters – those already set in their habits of voting, but only the very oldest cohorts (containing voters over 60 years old) are significantly debilitated.     

Party choice in hard times: Group-specific responses to economic downturns in Sweden

This article asks if, when, and why different groups of voters behave differently in the wake of economic downturns. We examine two Swedish elections (1994 and 2010) that were held just after two deep recessions (the financial crisis of 1991–1993 and the 2008–2009 Great Recession). We find that group differences were much larger in 2010 than they were in 1994. After the 1991–1993 recession, the government's electoral support declined across the board. In 2010, there were large differences between voters with low economic status (who were unlikely to support the government) and voters with high economic status (who were likely to do so). Our findings suggest that group differences in electoral behavior after an economic downturn depend on contextual differences across elections. We argue that future research should pay close attention to the magnitude of economic shocks, the development of asset prices (especially real estate), and changes in social policy.     

The information content of elections and varieties of the partisan political business cycle

This event study uses economic forecasts and opinion polls to measure the response of expectations to election surprise. Use of forecast data complements older work on partisan cycles by allowing a tighter link between election and response thereby mitigating concerns of endogeneity and omitted variables. I find that forecasters respond swiftly and significantly to election surprise. I further argue that the response ought to vary across countries with different institutional foundations. In support, I find that there exist three distinct patterns in forecasters’ responses to partisan surprise corresponding to Hall and Soskice’s three varieties of capitalism.     

Looking to the future: Prospective economic voting in 2008 Presidential Elections

Despite the economic turmoil of the time, a typical study of vote choice in the 2008 US Presidential Election would (falsely) find little evidence that voters’ opinions about the future state of the economy affected their vote choice. We argue that this misleading conclusion results from serious measurement error in the standard prospective economic evaluations survey question. Relying instead on a revised question, included for the first time in the 2008 American National Election Study, we find that most respondents condition their prospective economic evaluations on potential election outcomes, and that these evaluations are an important determinant of vote choice. A replication in a very different political context – the 2008 Ghanaian election – yields similar results.     

Forecasts and Preferences in the 1992 General Election

Little attention has been paid to the influence of expectations for victory on the formation of general election preferences in U.S. presidential races. There is good reason to believe, however, that under certain conditions citizens' forecasts of who will win the fall election may influence their preference and their vote. We model preferences during the course of the fall 1992 campaign as a function of two kinds of expectations. First we attempt to identify a component of expectations that is independent of political projection. We discover that expectations based only on information about the race play a prominent role in preference formation early in the fall but decline later as the cost of information drops. Similar results obtain when we include projection in the model of expectations. We conclude that general elections may have some of the same dynamic properties that are observable in primaries. Since early momentum in the fall campaign may influence subsequent preference formation, we contend that leads in early polls are valuable.     

Maximum likelihood estimation of structural VARFIMA models

This paper considers the maximum likelihood estimation of a class of structural vector autoregressive fractionally integrated moving-average (VARFIMA) models. The structural VARFIMA model includes the fractional cointegration model as one of its special cases. We show that the conditional likelihood Durbin–Levinson (CLDL) algorithm of Tsay (2010a) is a fast and reliable approach to estimate the long-run effects as well as the short- and long-term dynamics of a structural VARFIMA process simultaneously. In particular, the computational cost of the CLDL algorithm is much lower than that proposed in Sowell (1989) and Dueker and Startz (1998). We apply the CLDL method to the Congressional approval data of Durr et al. (1997) and find that the long-run effect of economic expectations on Congressional approval is at least 0.5718, which is over twice the estimate of 0.24 found in Table 2 of Box-Steffensmeier and Tomlinson (2000). This paper also tests the divided party government hypothesis with the CLDL algorithm.     

Information diffusion within the electorate:: the asymmetric transmission of political–economic information

This paper examines the connection between information and expectations. Drawing upon Lazarsfeld et al.'s (Lazarsfeld, P.F., Berelson, B., Gaudet, H., 1944. The People's Choice. Duell, Sloan, and Pearce, New York) classic work on communication flows, we devise an asymmetric transmission model of expectation formation. This model assumes that the expectations of the less informed segments within the electorate are influenced by the expectations of more informed groups but that the opposite does not hold. We use educational differences as a proxy for information heterogeneity. A vector autoregression (VAR) analysis on monthly surveys of inflation expectations supports the asymmetric transmission hypothesis.     

Presidential address— Seeing through the fog

All public policies have two things in common. They deal with the future and, as a result, they are based on forecasts or projections. The forecasts or projections may be implicit or based on naive extrapolation or ad hoc assumptions. They may be explicit and based on elaborate extrapolations or on behavioral models. In either case, unfortunately, they are notoriously unreliable. In fact, they almost always are wrong—sometimes just a bit wrong, but often massively wrong. Nonetheless, forecasts are what distinguishes reasoned planning from blind action. Without forecasts, we would be totally at sea. That we have to use forecasts or projections, that we know they will be wrong, and that they usually are wrong raise some difficult questions for policy analysis and policymaking. Regrettably, in my view, they receive too little attention.2 My purpose today is to urge that they receive more. My comments are intended to make four points. First, it is important for policymakers to appreciate how errorprone forecasts and projections actually are. Second, it is important not to permit the availability of projections or forecasts to obscure fundamental policy questions that are important in any plausible scenario. Third, uncertainty means that, where possible, it is prudent to design policies with builtin flexibility that respond automatically to diverse possible outcomes. Fourth, where builtin flexibility is impossible, complete analyses should take into account the consequences if forecasts prove wrong, and weigh those consequences against the results of postponing action until information improves or against other policies under the plausible range of possible outcomes. © 2000 by the Association for Public Policy Analysis and Management.     

Subnational electoral regimes and crisis recovery in Argentina and Mexico

The confluence of Latin America's volatile economic development patterns and transition to democracy has given rise to a proliferation of work on the national-level political causes and consequences of economic shocks and recovery rates. We explore the subnational electoral determinants of crisis recovery through analysis of growth rates in Mexico's thirty-one states and Argentina's twenty-three provinces following their economic declines of 2000–2002. Consistent with a theory that views intra-national variations in democracy as critical to understanding broader development patterns, we find that subnational electoral “regimes” significantly affect provincial recovery rates. Provinces that have an established electoral legitimacy prior to the onset of an economic shock, and those in which the governor enjoyed a substantial margin of victory, had significantly stronger recovery rates than those provinces stuck in a subnational regime transition with a sitting executive who lacked any claim to an electoral mandate.     

A Framework for Unifying Formal and Empirical Analysis

An important disconnect exists between the current use of formal modeling and applied statistical analysis. In general, a lack of linkage between the two can produce statistically significant parameters of ambiguous origin that, in turn, fail to assist in falsifying theories and hypotheses. To address this scientific challenge, a framework for unification is proposed. Methodological unification leverages the mutually reinforcing properties of formal and applied statistical analysis to produce greater transparency in relating theory to test. This framework for methodological unification, or what has been referred to as the empirical implications of theoretical models (EITM), includes (1) connecting behavioral (formal) and applied statistical concepts, (2) developing behavioral (formal) and applied statistical analogues of these concepts, and (3) linking and evaluating the behavioral (formal) and applied statistical analogues. The elements of this EITM framework are illustrated with examples from voting behavior, macroeconomic policy and outcomes, and political turnout.     

The Politics and economics of revenue growth: A cross–national analysis

Despite considerable interest in comparative fiscal policy in general, and the high salience of tax policy and tax reform in the industrialized democracies, there are relatively few cross–national studies of the economic and political correlates of revenues over time. We undertake a cross–national time series study of revenue growth in fourteen OECD countries between 1958 and 1990.We test a number of political and economic hypotheses about revenue change, including political business cycle, 'fiscal illusion', elasticity, and ideological theories. For the 1958—1990 period, we find that all countries, regardless of revenue structure, experience higher real revenue growth as a result of inflation, but that revenue growth is more responsive to unemployment in countries that rely more on direct taxes compared to countries with less direct–tax reliance. We find that this effect is most pronounced in the post–1972 period. We also find that revenue tends to increase in the years following elections, consistent with the idea that governments try to minimize the political fallout from tax increases by separating them as much as possible from election campaign periods; this effect, too, is most pronounced in the post–1972 period. We find no support for 'fiscal illusion' and ideological theories of revenue growth.     

Granger causality,rational expectations and aversion to unemployment and inflation

This paper presents a new test for rational expectations. This is done within the context of public concern, or aversion, over inflation and unemployment. It is found that inflation aversion Granger causes inflation, but unemployment aversion does not Granger cause unemployment. This implies both that inflation aversion is partially determined by expected inflation and that such expectations have a rational element. However, rational expectations of unemployment do not determine unemployment aversion. The consequences of these results for political business cycle theory are then examined.