Bankovní institu vysoká škola Praha Katedra finančnictví a ekonomických disciplin Politický a hospodářský cyklus v teorii a praxi Diplomová práce Autor Abbas Tursunmetov

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2.5 Alesina’s political cycle model

Alesina31,32 proposed an alternative approach to studying business cycles in the context of the actions of political parties and pursuit of some ideological goals. Using game-theoretic model with the assumption of rational expectations of the voters, it was concluded that, for example, in the U.S. the one can expect a recession at the beginning of Republican Party administration and expansion at the beginning Democratic Party administration. In the second half of both parties terms the output growth is expected to be similar with higher inflation in the Democratic administration. These theoretical results have been empirically confirmed

There are two political parties in the country, representing the interests of various groups of voters. Therefore, their aim is not only coming to power, but also to conduct economic politics designed to achieve different goals, realizing economic platform of their pre election campaign.

Thus, different parties are modeled as political figures with different objective functions. In other words, in pursuing the policy there is an ideological element.

The parties win an access for politics -making through elections with an uncertain outcome.

Let the parties D and R have different attitudes to inflation: Economic platform of the party R requires stabilization of prices, consequently, the target value of inflation is its zero level (π = 0). The party D allows the possibility to a non-zero- inflation (π =c) in order to stimulate economy and increasing employment level.

So, cost functions of parties D and R might be considered as target functions, related to the deflection of current economic situation from the most conducive (formulated in the economic platform) for arbitrary period t



where ZtD, ZtR parties costs D and R respectively;

yt-output growth rate, c› 0, b’ ›0
Then the costs of indefinitely long time living politicians, presenting the interests of every party, will be equal to discounted sum of their costs for each period


where q - discount multiplier that reflects the temporal preferences.
Output in the economy varies accordingly to Lucas graph, presented in the growth rates' record for the variables measured on a logarithmic scale. In other words, for the short-term period growth rate of actual output y, might deflect from the growth rate of potential y if there is unexpected change in the rate of inflation


Believing that the potential output does not change (ỹ — 0 )

let’s simplify the cost function of the party D, having substituted (2.5.5) in (2.5.1)

Where b=b’ and

Now we shall examine the cost function of the party D without excluding the last summand (addendum)in (2.5.6), which is constant for each period:

Thereby, the outgoings for the party D decreases when unexpected inflation occurred, which stimulates economy and increases employment and output. Therefore, there exists incentive to unexpected inflation.

Ruling politician has the ability to use the instruments of monetary regulation and thus directly control inflation. Political elections come at predetermined intervals of N years, in the beginning of the period. The winning party forms its policy right away by determining the rate of inflation.

It is well known that he elections with probability P wins party D and with probability (1 - P)- the party R.

Voters are rational, informed of the purposes and economic platforms of both parties and are able to predict the situation, considering past experience.

As there is uncertainty about the preferences of voters, the election result is not defined. This incertitude creates the existence of economic cycles in the economy with the two-party system and the rational consumers.

In other words, the situation may be represented as acting model with two actors - the politician and the population(voters). Let’s analyze its possible solutions.
2.5.1 Discretionary balance in the one-step acting
If considering situation become only once, e.g. there is one-step acting, , it turns out the so-called discretionary balance or the balance at circumstances.

Politian minimize its expenses at given current and future actions of the population , as well as its own future actions.

Population creates expectations: contracts are made the year preceding election. In this case, it is known probability of election victory R and 1-R.Therefore, if the party D wins, then every time it will minimize the outgoings of given peoples’ expectations, that is, to solve the problem
Solution of this task defined by the condition


Hence, equilibrium significance (rate) of inflation in case of party D victoryexceeds the target level for any period t


If party R is chosen, then each time it will minimize its outgoings for given peoples’ expectations i.e., to solve the problem


Hence for any period t


In this case equilibrium level of inflation coincides with target. Let’s suppose that while concluding labor contracts, population sets the tempo of wage changes on

the level of expected inflation. Then, in an election year, when there
exist uncertainty about results, expected rate of inflation, and hence the salary rate will formed on the level

For all other years of the election cycle there is no any suddenness accordingly

Now we will view growth rate of output during election cycle

By using the cycle of short-term supply of Lucas (2.5.15), we will obtain sudden inflation and output growth in the case of party D win:


Hence actual output grows, unlike constant potential (ỹ=0), i.e. we observe cyclical upswing.

However, if the party R wins elections, there comes the cyclic recession, output has a negative growth rate.


In other periods there will be no surprises, therefore release increases with the growth rate of potential, regardless which party came to power. Basing on analysis of(2.5.15) and (2.5.16) it might be done the following conclusions:

1. Divergence range of actual growth rate of the release from potential, positively associated
with the magnitude of the differences between parties target benchmarks. In other words, the
greater the difference between c and zero and more incentives differentiate for each party to inflate the economy (b and 0), all else being equal, output growth rate will deviate more from zero. The more polarized are the political parties, the more cyclical fluctuations undergo the economy.

2. The less likely the rise to power of party D, the more is cyclical recovery in case of its victory, and the less cyclical decline in case of selecting the party R. In other words, the less likely the policy, the greater the actual effect.

3. The equilibrium inflation is always higher when in power party D, for two reasons-the optimal inflation rate of this party is higher, besides it has a sufficiently serious incentive to generate inflation to stimulate economy.

It should be noted that none of listed conclusion would not change in content, if both parties had identical optimum of inflation rate c= 0.

Now we should define the equilibrium values ​​of target function of both pairs ẑtD and ẑtR In accordance with (2.5.14)in any year, except for the election year, the equilibrium costs of the party D represent measured costs by the probability in case of victory
and the loss of the party


Similarly, for the party R


Obviously ẑtR rises with the increasing probability to loss the election, as well as the growth of target level inflation of party D and sensitivity to unexpected inflation.

Equilibrium outgoings of party D decreases with increasing probability to win at election, only if the magnitude b, determining the incentive to unexpected inflation, not too
high and does not exceed the target level of inflation c. Thus it is defined implicit constraints for the ratio of target level of inflation for the party D and costs sensitivity of this party to an unexpected inflation.

Introduction to practical part

The U.S. economy - the world's largest economy, constitute not less than a quarter of the world's GDP in nominal terms, since the end of World War II. is most diversified national economy, leading in the global economy for the last 100 years. However, since the early 2000s, as a result of economic crisis shocks that originated in America and shocked the world economy as well, America loosing its dominating role. with acceleration of globalization and the constant growth of the 2nd largest economy in the world (China), its increasing influence. The dominant role of the U.S. every year declined in the global economy. And despite all the difficulties, embarking on her way, she still remains the most powerful.

GDP(PPP) of the country for the year 2012amounted to $15.811 trillion.

The world economy in its chronology (development) has a number of economically, politically and historically important epochs influenced all subsequent world order. To such milestones we could include formation of the United States as a state and its rapid development in the post-industrial era.

Despite common to all market economies functioning mechanism which has developed over a long period of development and based on the basic principles - private property, power of competition, supply and demand ratio, non-interference and market self-regulation. Economic and social development of some countries defines by a number of traits and peculiarities, acquired and developed in a constantly changing world. Their experience of development makes the economy - unique of a kind. Global economy distinguishes several models of economies with their inherent features suitable to adapt in other countries: American, Japanese, German, French and Swedish.

Models of political, economic processes in different countries formed by objective and subjective factors of society development, including the influence of considered theoretical concepts. In each country some of these concepts have been implemented, often in specific combination. This was attested primarily in models of their economies and to a large extent determined their specificity.
The economic model - it is a formalized description of the economic process or phenomenon, which structure is determined by its objective properties. Displaying of economic phenomenon within a distinct economic model based on a comparative analysis, which consist in fixing investigated phenomenon as well as consideration of its development specificity within global economy.

The American model is the liberal, market-capitalist model that assumes a primary role of private property, market-competitive mechanism, capitalist motivation, high levels of social differentiation.

The main traditional traits and peculiarities of American liberal economic model:

    The widespread promotion by American society, State, entrepreneurial activity, a favorable business climate, public line to success for everyone, regardless of his origin and social status;

    The relatively low level of GDP redistribution through State budget less than 17-18% through the Federal and about 30% consolidated budgets.

    the relatively low share of State in industrial GDP (about 12%). State ownership represented only in the nuclear industry, productive infrastructure (bridges, roads, pipelines), in education and health;

    more limited than in many other developed countries, but very effective State intervention in the economy.

These characteristics are the basis of American liberal economic model.

The second group includes: new features related to NTP, acquires great importance in recent decades,

    In particular,-Globalization of business-more than a half of the revenue of major US corporations are created abroad: production which can adapt to the rapidly changing needs of the economy and the population. achieved by using of STP results, the latest technologies in math. manufacturing and service sectors.

   level of research intensity - in the structure of the American economy propelled by overall increases in spending on research and development (R&D). President Obama33 requested $ 147.696 billion for research and development (R & D) in FY2011, $ 343 million (0.2%) increase from the estimated R & D FY2010 funding level of $ 147.353 billion.

    A qualitatively new feature –The information revolution the role of information infrastructures in the effective functioning of the economy and society already became undisputable. The basis of the information infrastructure in a processing industry, broadcasting and information sales (IT, media companies).If until recently the country's economy was moving forward by automobile production and housing, now this is information technology. At the beginning of XXI century the United States. accounted for more than 40 % of the world's working computers, manufacturers of PCs and chips in the world at a fraction of the United Internet plays more perceptible (appreciable) role in the economy: the volume of commercial transactions via Internet in 2003 reached $ 1.3 trillion, only on U.S market of online advertising revenues for 2012 amounted to 38.3 billion of dollars.

    the role and scope of services, which have no analogues in other developed countries. here was focused around 80% of employed persons, about 40% of the basic production assets (funds), (in 2004) services have created approximately 79.4% of GDP. The value of services, however, are not limited to increasing its share of GDP and the concentration of resources and capital. Investment of this sector concerns most of all the development of science, education and health.

    A key feature of dominant private sector is the structure’s evolution of production capital. Corporate private property has become dominant over all (partnership, individual private property). A proliferation of new forms of private ownership got distribution: investor-owned companies (more than 80% of the share capital of the country's corporate sector)-corporate America.

    The trend of reducing the scope and influence of trade unions in the labor market and the labor relations of employees up to 1.5% in 2005. Trade unions’ reduce of influence in contracting, employment and wage level decrease, the market becomes more mobile.

  • Finally, the changes in the functioning of commodity markets as well as dynamics of the business cycle. Along with the inculcation of information technologies and the influence of NTP, the most important factor was the cycles changes and state regulation of the economy, influence of policy. Cycles’ smoothing out attests business downturns until 1929 were longer and deeper, than in the period after 1945 According to NBER business cycle chronology, for example, reduction phase before 1929 on average lasted about 21 months, whereas expansion phase approximately 25 months. After 1945, the contraction phases became shorter about 11 months, and the expansion phase elongated up to 50 months. New researches shows that in the mid-1980s, economy’s fluctuation amplitude lowered, and so far remained low. Stock and Uatson33 learned many available sources of production and service sectors, considered the changes of firms’ commodities fund, trends of lodging(housing) market, the major oil price shocks, shocks of prices drop on consumer goods and food, monetary policy enhancement and came to a clear conclusion, that from 20 to 30% reduction of GDP’s amplitude fluctuation explains by improved monetary policy.

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