Freeman - Houser - 1988 - A Computable Equilibrium Model For The Study of Political Economy

A Computable Equilibrium Model for the Study of Political Economy Author(s): John R.
Freeman and Daniel Houser Source: American Journal of Political Science, Vol. 42, No. 2 (Apr., 1998), pp. 628-660 Published by: Midwest Political Science Association Stable URL: http://www.jstor.org/stable/2991773 Accessed: 05/11/2010 10:06
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A Computable Equilibrium Model fortheStudy ofPolitical Economy*

JohnR. Freeman,University of Minnesota Daniel Houser, University ofMinnesota Theory: The needforthedevelopment anduse of a concept ofjoint,political-economic is increasingly of democracy equilibrium recognized by students and markets. Yet,to and methodological of thiskindhas beenprodate,no adequatetheoretical synthesis which duced.The fewworks haveattempted it suffer from a lackof theoretical balance between economic andpolitical of theory; unrealistic, temporally aggregated conceptions political-economic equilibrium; failure toincorporate theoretically meaningful stochastic elements of economic andpolitical processes; and theabsenceof a coherent methodoltheempirical ofpolitical-economic ogyfor gauging power models. Methods:In thespirit of theAJPS workshop, it is shownhow theseproblems can be solved.An improved modelis built,one whichfusesa branch of real businesscycle andthetheory ofpresidential theory approval. Thismodelproduces a notion ofcomputable political-economic formarket and simultaneous equilibrium that provides clearing stochastic optimization by economicand politicalagents.Then,usingdata analysis in parallel techniques developed byrealbusiness cycletheorists (Hansenand Heckman 1996; Kydlandand Prescott 1990, 1996; Lucas 1987; Prescott1986a, 1986b, 1991; Sims 1996) andpolitical methodologists (Brady1996; Jackson 1995),themodelis parameterized for theUnited States. Morespecifically, on thebasis ofestimates from economicsandpolitical scienceand somenumerical certain ofitsparamexperimentation, etersare set so that,whensimulated, themodel mimicstheUnitedStatespolitical in the1980s. economy The parameterized Results: modelis usedto study someimportant counterfactuals. The first is theimpact of increased on political-economic approval volatility equilibration. in viewofAmerica's Suchvolatility is expected in thepostCold War involvement likely era's increasing number of "low intensity" international conflicts. The secondis theimof approval. pactofpresidents pursuing relatively high-nonminimum winning-levels This kindof behavior is attributed to certain theclaimthat it has presidents alongwith harmful on markets effects and henceon variousfacetsof social welfare. The former
*Thisis a muchcondensed version ofa paperdelivered at the1995Annual Meeting of theAmerican Political ScienceAssociation, theHubert Humphrey Institute's seminar on TradeandDevelopment, andon theCommittee for Institutional Cooperation's political science, interactive videosemi: nar.The authors gratefully acknowledge theresearch assistanceof Paul Kellstedt and Marcelo Veriacerto and theresearch support of theNational ScienceFoundation. Foruseful comments and criticisms we thank anonymous referees, James Granato, Robert Holt,John Jackson, Ken Kollman, in the Ido Oren,Diana Richards, GeorgeKrause,Eric Lawrence, Terry Roe, and theparticipants abovepanelandseminars. The authors areresponsible for thepaper'scontents. AmericanJournalof PoliticalScience, Vol. 42, No. 2, April1998,Pp. 628-660 (D 1998 by the BoardRegents oftheUniversity ofWisconsin System
A COMPUTABLE EQUILIBRIUM MODEL
629
in part, to (Lucas 1987) can be traced, analysis showshow"business cyclephenomena" in an increasingly polity, manvolatile international government approval management investigation a slight dropin socialwelfare. The latter agement which is associated with target is notnecessarpursuit of a consensual approval demonstrates that thepresident's ilysocially harmful.
development Atthe heart ofthestudy ofdemocracy andmarkets arethe ofconcepts andpolitical equilibrium. andanalysis ofeconomic equilibrium ofequilibrium are scholars haveargued that thetwotypes Recently, many on theoutequilibrium depends to someextent intimately related, market on market andthese outcomes clearing comesofpolitical hinge processes Thecounterfactuals that ofmarkets be understood. must anddemocracy that in economics andpoliticalsciencecan notbe addrive theory building concept alone. equately analyzed with oneequilibrium theoretical fewscholars haveattempted thenecessary Unfortunately, for advances major andmethodological Take, instance, twoofthe synthesis. andourtheory ofapproval ofthe1980s:realbusiness managecycle theory in economic in theformer is defined ofagents solely ment. Themotivation processes ofthemodels aretiedtoeconomic terms; thestochastic elements with ofequilibrium has todo solely with market clearing alone;thenotion for inthe ofgovernment (represenpolitical strategies noprovision stability inthe ofrealbusiness modtative cycle performance agents). Improvements ofadditional like els aresought the stochastic elements introduction through Meanwhile, thepolitical origins ofwhich arenever explored. fiscal shocks, for the to buildmodels without anyequations approval theorists continue arenot for provided-reRationalizations approval specifications economy. inthem are tobe usedandthe terms usually forms continue stochastic duced ofequiliin anysubstantively notinterpreted meaningful way;thenotions arenotdeform with these reduced approval equations bration associated letalonetheagents which aprational agent, rived from the behavior ofany models.For example,the now popularerror pear in macroeconomic oftherational of correction modelis notshown tobe theresult strategies series and thetime decomposition Methodologically, anypolitical agents. arenoother dataanalytic usedbyrealbusiness cycletheorists techniques in theapproval andStimson tobe found literature 1994). where (Freeman in separate realms thuswork Real business theorists cycleand approval As a result, possiblegains without intellectual exchange. anymeaningful ofwork arenot realized. Andimportant these two bodies from trade between inwhich United States about such as the impact increasing questions things in thepostCold War in "low intensity" conflicts volvement international
equilibration and related economicprocesses.It is the joint or simultaneous
630
and Daniel Houser John R. Freeman
on markets andecovolatility and,in turn, haveon approval world might welfare remain unanswered.1 nomic haveattempted sucha synthesis. Table1 suma few scholars Ofcourse, forexrecent ofthese contributions. Consider, marizes someofthemost Thesemodels usually provide under thesecond column.2 ample, thework rule. Eachparty andits under orplurality majority for competition two-party Government is conobjectives. is assumed to havedifferent constituency an agent which incumbent impleas a self-interested party, ceivedeither whose is tooptimize oran agent objective ments a bargain between parties, is conofthe functions utility (see below).Government the parties' product or relationships andpolitical strained in these regards bya setofeconomic is thesolution to motion." Policy thus and(or) economic "lawsofpolitical problem. the constrained optimization respective inthis is arguably Alesina's research work genre well-known Themost "A Model andRosenthal, with Londregan hispaper (1987,1988),including ofthe States" Londre(1993).TheAlesina, ofthe Political United Economy ofAmerican repremodel incorporates keyinstitutions gan,andRosenthal Forinstance, for andcongrespresidential itprovides sentative government. ofpolicy bythetwo outcomes andfor jointdetermination sionalelections inpart, on ina stochastic growth depends, branches. Parties world; compete in "poeconomic events andfluctuations shocks unanticipated representing to avoidinefficiency; cf. abilities (administrations' liticalcompetency" for and ofvoters' inflation andSibert preferences 1988).Therange Rogoff produces a Party competition period. randomly eachelectoral growth varies
inparticular arereviewed andrealbusiness in general cycletheory 'The newmacroeconomics is associated theresearch ofLucas (1980, 1987), this work with 1993).Briefly, elsewhere (Freeman of stochastic economies, itintroduces thenotions Amongother things Prescott (1991), and others. inwhich theimpact oftechnology is inherwith andevolution functions e.g.,economies production is shown to be equivalent to that of a beofthecompetitive economy ently random. The behavior 1989). optimization (Stokey, Lucas, andPrescott whoengagesin stochastic nevolent socialplanner is evident in such thepolitical motivations of agents largely ignores Thatthisschoolof economics andSchofield (1993,466); Hinich, andKehoe(1991,esp. 529); Barnett, works as Chari, Christiano, ofselected economic theorists test for theexogeneity andMcGrattan (1994,esp. 9). Some approval thesetheorists assumethat the(enand Stimson 1992). But,usually variables (MacKuen,Erikson, is no rationalization of (Durr1993),there is exogenous. With one ortwoexceptions tire)economy hastodo with thetime series properties oftheaptheapproval The notion ofequilibration function. andrelated conditions forcompetitive economic datarather than anyidea ofmarket clearing proval in approval, of a moving unemployment, equilibrium Illustrative of thisis thenotion equilibrium. andSmith (1993). Politiandinflation byan error correction model(ECM); see Ostrom as governed ofanyrational political (or cal scientists havenotmadeanyattempt tolinktheECM tothebehavior haveexisted forsometime suchrationalizations economicagents. This is in spiteof thefactthat (Nickett 1985). in Table 1 arereviewed is in 2Tosave space,onlya subset oftheworks here.The fullreview Freeman (1995).
C.
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0~~~~0
00
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K~~~~~~~
41 CY
0~~~~~~~~~~~~~~~0
C)~~~~~~~~~~~~~Y
CC)
~
C)
~~~~~~0
CY
v-(
C)
C) 00 CO
C)"d~~~~~~~~~~~~~~:
632
John R. Freeman andDaniel Houser
coalition Nashequilibrium proof that connotes time consistent policies and particular ofgrowth. Thisequilibrium patterns alsoimplies a pattern ofelectoral outcomes which areconsistent with keyfacts about suchthings as the recurrence ofdivided government. Lesserknown butequallyimportant contributions in thisgenre have beenmadebyEuropean Forinstance, scholars. vanderPloeg(1987)usesa model toexplore two-party competition the ofrational implications expectationsin smallopeneconomies with uncertain electoral In his outcomes. thedomestic realinterest models, rate is pegged totheforeign interest rate (which is exogenous), arerisk speculators neutral with information perfect andforesight, andgovernment is a Stackelberg leader whose is incumbency determined elections. VanderPloeg compares probabilistically through policy choice when is a benign government tothat planner when incumbents facepossible electoral that in thelatter defeat, showing situation politically induced intheeconomy swings canoccur as government anticipates losing office andtakes actions tooffset theeffects ofitssuccessors' policies.3 Another contribution is madebyDrissen andvanWinden (1993).They construct a model basedon formal theories oftwo-party under competition rule andprobabilistic majority Inparticular, voting. Drissen andvanWinden theresult that when exploit individual choiceprobabilities areproportional totheir ofpreferences, strength willmaximize government the Nashproduct oftheimplicit ofthetwoparties' utility functions constituents (Coughlin andNitzan1981;Hinich1977).Usingthis theassumption result, that the constituents ofthe twoparties arelabor andcapital, andan augmented setof inthe economic constraints-augmented sense that sector public production is addedto theequations conventionally usedtorepresent thecompetitive economy-Drissen andvanWinden areabletochallenge theconventional wisdom fiscal about Forinstance, ofa taxincrease policy. theimpact need notleadtoa reduction inprivate sector as itdoesinpartial production equilibrium models inwhich taxchanges arenot constrained bypolitics.4
3In vanderPloeg's set-up foreign interest ratesaretreated as exogenous causesofchanges in domestic realinterest rates. Rational expectations areintheform ofjumpvariables; that is,variables which areforward looking andnotconstrained bypasthistory. Jump variables aredetermined inefficient financial markets and takeintoaccountexpectations of future eventsso thatcredible announcements of changesin future economicpolicyaffect thecurrent stateof theeconomy. Real competitiveness andrealexchange arejumpvariables rates in themodel.Parties maximize alternativeobjective functions, functions whichare discounted overperiodsof electoral in uncertainty terms oftheprobabilities ofreelection ofincumbents. See also vanderPloeg(1984). 4Stochastic elements are implicit in Drissenand vanWinden's piece (1993). No expressions forprobabilistic votingare made in the equationsystem.Government simplymaximizesthe weighted product ofthetwoactor's utility functions theweights areofthe"influence" va(VC,Vw); riety(P = VWCV'w where + pu =1). Political economic equilibrium is defined as the joint maximization ofhousehold and government utility where theformer treats policyas givenandthe latter treats household maximization as a constraint.
633
Thesemodels areamong the most promising interdisciplinary syntheses constructed todate. Among other things, they expressly incorporate political In somecases,their motivations for agents. creators attempt toshow that the models canexplain ofvarious kinds. empirical patterns Unfortunately, as modelsof political-economic equilibration, these works arestilldeficient in a number ofimportant To beginwith, respects. themodelsoften do notstrike a meaningful balancebetween economic and political For example, in theDrissenand van processes. thepolity in an important naWinden thestochastic pieceis underdeveloped respect: tureof thepolitical behavior is implicit notexplicit. In thecase of the itis theeconomy Alesinawork, which is underdeveloped-a simple supplyfunction absent ofanyeconomic rationalization is all that is provided. In effect then, Alesina'smodelshaveno economic agents.5 Second,the ofpolitical-economic temmodels arehighly conceptions reality in theseporally aggregated. Political-economic arerealized equilibria onlywhen presidential elections occur; inthis sense, "theworld starts over every four years" (Alesina, Landregan, andRosenthal these models 1993,26). Third, failtoprovide in theeconomy forstochastic elements andpolity. usually In almost all thecases,deterministic ofproduction, conceptions voting, and other now keyprocessesare employed despitethefactthat theory stresses theimportance of suchfactors as technological innovation and in preferences. randomness Concomitantly, there is stillno relation between theformal modelsandreduced in thisresearch. forms employed The mostglaring of thisproblem areAlesina'spapers(1987, examples therational 1988)where expectations business cycleset-up bearsno relation totheequations arefit which todataandno interpretation oftheerror in thestatistical term is supplied. of economics and As syntheses set-up inneed political science then, these models areimportant advances butstill ofsubstantial improvements.6
function. His 5Alesina's models represent theeconomy as a single equation-theLucas supply evenin modelsdo notprovide foroptimization byeconomic agents. The lackofbalanceis evident Economy: Instithenewest andbestcontributions suchas Barnett, Hinich, and Scofield's Political oftheart.However, most tutions, Competition, and Representation (1993). Thisbookis truly state ofthearticles in itstudy thepolity in isolation oftheeconomy. 6As regards to thefourth point, Alesina,Londregan, and Rosenthal's model(1993) is genuButthis inely stochastic. Andthere is a more direct relation between itandtheestimation equations. "mechanisms" that relation is notone-to-one. Rather, their maximum likelihood function contains arenotin their formal model(see esp. 1993,21). Neither vanderPloegnorDrissen andvanWinden ofextant politipresent anygeneral strategy forusingtheir modelto explain theobserved behavior In thecase oftheformer, from a British cal-economic theauthor lifts Treasury systems. parameters thehistory model;hepresents simulation results butdoesnotattempt to showthat theresults explain ofBritain orof anyother is purely abstract. Theyoffer country. DrissenandvanWinden's analysis no parameter for their ofitsimplications. In principle, themethod estimates modelorstatistical tests belowcouldbe usedto gaugetheempirical ofbothmodels. presented power
634
improvethis paper shows howthese Inthe spirit ofthe AJPSworkshop, ofapproval maincycle theory andtheory ments canbe made. Realbusiness in waysthat rational economic and political incorporate tenance arefused elements ofpolitical andeconomic probehavior as wellas keystochastic of optimal fiscalpolicy(Chari, cesses. In particular, themodern theory with scientists' work andKehoe1990,1991)is merged political Christiano, onpubAs inthe taxrates andinterest rates former, onpresidential approval. present value ofthe return toa representative licdebt optimize the discounted constraints. Firms in keeping economic household with well-established that markets clear. Buthere maximize Andprices andwagesaresuch profits. As inourpolitical for theory, there alsois provision accountability. political a paris motivated toachieve Andgovernment households dispense approval. and Smith1993;Williams ticular approval rating (Brody1991; Ostrom mois anapproval constraint anda politically 1990).Morespecifically, there thediscounted value of expected tivated present agentwho minimizes In addition, the model is defined deviations from itsapproval target. squared techinterms realization ofthree random variables representing ofthe joint shocks. spending shocks, andapproval nological innovation, government from this a concept ofcomputable construction, political-ecoThere emerges stonomic that describes market clearing and,simultaneously, equilibrium andpolitical Thecorresponding, chastic agents. optimization byeconomic allocation is solved for thedecision rules of motivated problem" "politically inparallel dataanalytic both by techniques developed agents. Then, using and (Hansenand Heckman 1996; Kydland real business cycletheorists 1986,1991;Sims 1996) andpolitical Prescott 1990,1991,1996;Prescott 1995),themodelis appliedto the methodologists (Brady1996;Jackson inthe basisofestimates from ecodiomOnthe United States 1980-90. period numerical certain parameters ics andpolitical science-and experimentation, inthemodel aresetso that itmimics theUnited that simuStates, is,when properties the model time series which, when detrended, have lated, produces time arevery similar tothose ofdetrended actual datain theindicated that frame. The detrending is that method usedbyrealbusiness cycletheorists inpolitical ofcitizens ofecoandimplicit scientists' analyses appreciation and nomic constraints: theHodrick Prescott (HP) filter (Hodrick feasibility counterPrescott themodel is usedto study someimportant 1980).Finally, factuals. Oneofthese is mentioned above:theeconomic andwelfare conseinapproval inofthe increases which America's increasing volatility quences inthe ColdWar's conflicts is likely tospawn. volvement "lowintensity" post The other is an assessment ofthepolitical andeconomic of implications levelsor,of winning-approval presidents pursuing high-nonminimum what is calledeuphemistically presidents "loving dangerously" (TheEconoshows how"business analysis mist, January 24, 1994,21-4). The former
635
in part, to government cyclephenomena" (Lucas 1987)can be traced, apinan increasingly proval management volatile international polity, manageis associated a slight insocialwelfare. Thelatter ment which with invesdrop thepresident's ofa consensual demonstrates that tigation pursuit approval is not In these harmful. the desired theoretitarget necessarily socially ways, anditsvalueis demonstrated.7 cal andmethodological is achieved synthesis A ComputablePolitical-Economic EquilibriumModel
TheEconomy
orders ofconAssume that therepresentative household stochastic streams and labor by: sumption
max E,
C
ptu(st)U[c(st), (st)]
SI
[1]
stis thestate ofthepolitical attime where ,3is itsdiscount rate, economy t, at time that a particular state occurs theprobability u(st)represents t,and in conconcave function strictly utility increasing U[ ] is thehousehold's inlabor, c and l depend onthestate, sumption, c, anddecreasing X,where is defined St.8Say, production technology by
y = Z(St)(1 + p)tf(t)
[2]
is a function butalso ofa "growth factor" anda orthat oflabor output only stochastic process,z. The term(1 + p)t represents positiveexogenous
of theworkofAlesina,Londregan, and Rosenthal (1993), 7Our modelthusis in thespirit unlike Jackson's (1989), andJackson (1995). Forinstance, Brady(1996), BradyandAnsolabehere agents arefully rationalized in ofpolitical (andeconomic) (1995) set-up, in ourmodel, thebehavior is temporarily ofoptimization economic disaggregated-equilibration reality terms theory; political is based on numerical or quarterly four years;and,ourparameterization occursmonthly notevery to themodelofAlesina, In comparison experiments fora particular era of UnitedStateshistory. with optimizing households has a fullblowneconomy Londregan, andRosenthal (1993), ourset-up andeconomic processes. andstochastic political do notpermit oftheHodrick-Prescott a fulldescription andevaluation (HP) Space restrictions thisfilter is used to decomposetimeseriesintoa long-term component (roughly filter. Briefly, or low frequency) to high component (medium and a medium/short term greater than32 quarters is essential becausedifferent Real business holdsthat thedecomposition frequency). cycletheory liteachcomponent ideasinthepolitical economy forces determine (cf.Lucas 1980,1987).Parallel of (1993) concept Londregan, andRosenthal's erature areembodied inAlesina's(1988) andAlesina, ThisAppenrates. Thefilter is described detail inthe tothis paper. natural inmore Appendix growth dix is available at the Political Methodology Paper Archive(http://wizard.ucr.edu/polmeth/ from It also can be obtained theauthors. polmeth.htm1]. productivity, govbelowin terms ofthejointrealization of independent 8Again, stis defined for matrix theseshocks. Cf. shocks, andu( ) is a Markov transition emnment spending, andapproval Prescott Stokey, Lucas,with (1989,esp. Chp. 11).
636
as the is interpreted cycle theory itnormally growth, p ? 0. Inrealbusiness overtime. z is an inditechnology shocks augmenting sumofproduction is strictly for theefinstance, exogenous, shock which vidual productivity intheprice ofa critical input likeoil. surge (decline) fect ofan unexpected spending legislation, as nondiscretionary dueto suchthings Assume that rate, p. Thenthefeasigrows atthesameexogenous government spending by the reconciles thelevel of consumption or resource constraint bility g: andgovernment spending, household
C(St) + (1 + p)tg(st) < Z(st)(1 + p)tf( 3t))
ofunits debt ateachpeofgovernment Thehousehold purchases a number V. w,andprofits, on thedebt as wellas wages, interest riod, b.Anditearns atrate, t. on thedebt wagesatrate, R, andtaxes Government paysinterest thefollowing problem: Thehousehold therefore faces
max ,
C
ptu(st)U[c(st), ?(St)]
SI
[4]
such that
c(s') + b(sl) < (I
-
T(sl))w(slr)?(sl) + V(sl) + R(sl)b(sO) + A
t=
c(st) + b(st) < (I - t(st))w(st)t~(st)+ R(st)b(st-l) + V(st) t = 2, 3,

c(),(.) > 0, (.) < 1.
andlabor thedistomaximize consumption chooses Thatis,thehousehold itsinitial valueofitsutility to a condition relating counted subject present thesumof andthegeneral constraint that anditsinitial wealth purchases or at timet is less than debtpurchases andgovernment itsconsumption ofitsnetwagesattime from holding earnings t,previous equaltothetotal inithehousehold's debt att- 1,andprofits earned atthetime t.A denotes Forthese firms comtialassets. Thehousehold is assumed toownall firms. that ensures petitive equilibrium
v(st) = max{z(st)(I + p)tf[e(st)] - w(stf((st)} [5]
theprofit levelis that which maximizes thedifference between outor,that tothestochastic variable, is subject output again, putandnetwages(where,
factor, (1 + p)t).9 z(st), and theexogenousgrowth
all markets that firms optimize andthat 9Thegeneral equilibrium framework usedhereimplies for households andtheproduction for theeconomy are clearfor eachst.Theutility function function below. characterized morefully
637
ThePolity
Government is aninfinitely-lived whochooses agent taxrates, t, andinon public terest debt, R, so as to minimize theexpected sumofdeviations from itsapproval APP*. Specifically, target, government's preference is of theform
MinXXtu(st)[(APP(st)
,rR
APP)].
[6]
SI
,3is thegovernment's discount rate andu( ) is defined as before. Now,assumefurther that government facestwoconstraints. The first is expressly innature: political
APP(st) = ?o + a,
+ (1 + eP1(s)e(t
c(st)
e(st)
[7]
householdcontributes to production. thelast variable,e(st), repreFinally,

10 events.
whereoc1 and oc theimpact 2 represent ofwhat we willcall "normed conandlaborinput on approval, sumption" ande is a random respectively, or disturbance term andother representing rally random shocks essentially to The first approval. variable on therhsof [7] captures thenowwell-acidea that cepted approval on citizens' depends material It also well-being. captures theargument that as rational agents citizens takeintoaccount the fact that levelschange, inpart, consumption becauseofforces that arebethecontrol ofgovernments. yond Herethis for "economic feaadjustment amounts sibility" to dividing out of c(st) theexogenously determined growth factor, (1 + p)t.The secondvariable on therhsof [7] represents a non-material determinant ofapproval, theamount oflabor specifically, the sents In theapproval shocks. approval these areassociliterature, usually atedwith one-time surprise andespecially domestic, international, political
10Political scientists have employed thenotion of government approved forsome targeting time. An illustration is Schultz's(1995) recent oftheBritish analysis political business cycle.Like us, Schultz employs a target he calls thegovernment's level."Unlikeus, Schultz "security emphasizes electoral timing. We return to thisdistinction in theConclusion. An example oftheincorporationof citizens'appreciation forthemacroeconomic constraints on government is Chappelland Keech's (1985) use oftheexpectations-augmented Philipscurvein their "sophisticated" modelof presidential approval. We heresimilarly assume citizens aresophisticated enough torealizethat consumption grows inpart duetotheexogenous growth factor, (1 + p)t. Hencetheir willingness todispenseapproval varies inrelation tothis trend. As itturns out(see below),thissimple formulation a largeamount explains ofthevariance in approval. As regards e(st), thisterm captures thecommon of"rally" notions or "extraordinary" ap-
638
John R.Freeman andDaniel Houser
Thesecond constraint ongovernment is itsbudget constraint. Thisconstraint reconciles thenumber ofunits ofdebt issuesanditstax government collections with thereturns itpaysanditsexpenditures:
b(st) + T(St)W(st)?(St) = R(st)b(st-l) + (1 + p)tg(st). [8]
In ourmodel, then, government spending is, in effect, determined exogandKehoe1991,522) andtaxrates, enously (Chari, Christiano, debt public issues, andinterest rates on public debt areadjusted tocover that spending level.
PoliticalEconomicEquilibrium finethispolicyas =l(St) _ (t(st), R(st)). Thus thegovernment policyis in-
Government amounts to a mixoftaxesandreturns on debt. policy De-
= government's policyas 11_l(St). Let x(5t) =_(c(st) ?(st), b(st)) represent
dexedby the stateof thepolitical-economic the world, st.Abbreviate
the allocationfortherepresentative household forst.Abbreviate this
for policychoices,or x(l) = (x(stll)). Andmarket equilibrium implies = V(stIll).It follows thatw(rj) = w(stjll)andfor prices thatV(ri) profits
therefore thata political motivated economicequilibrium is a combination of decisions,{fl*,x(.),w(.),v(.)} suchthat
x =_x(st). Now thehouseholdbases itsallocationdecisionson government
I. il * solves thegovernment's problem:

Min 6,
tr,R t E S
tu(st)[(APP(st) - APP
*)2]
subjectto
APP(st) = cxo+ aC + OC2t(St)+ e(st) t+U~ (I + p)
provalshocks(Brody1991; Ostrom and Smith1993). (Technically, theinitial con(XI embodies levelc(s?), morespecifically, sumption
=c(so)
where&a is thecoefficient in themore complete expression A(st) = aO + (1 + p)t c(s)

+ i2t(st) + e(st).
We do notattempt toparameterize butrather subsume itsvaluein al .) c(s?) here,
639
and
= R(st)b(st-lrl) + (1 + p)tg(st). + c(st)w(stjI)tl(st[n) b(stliv)
II. Forevery with problem policyrl' il', x(fl') solvesthehousehold's andprices, V(il'), given. w(f') andprofits, III. Forevery if
w(st lr) = z(st)(l + p)tf'[e (st l1)] = Z(st)(l + p)tf[e(st[rl)] - W(St[l)4t(St[l). V(Stlfl)
The corresponding or"politically motivated allocaprogramming problem tion problem" then is:
Min 6 suchthat c(st) + (1 + p)tg(st) = z(st)(i + p)tf[4?(st)] itu(st)[(APP(st) -APP [9.1]
E E j3tu(st)[U
t St
(st)c(st) + U(Sts)tl(st)] = UC(s1)[R(s1)b(s0) + A]

= aO +
[9.2]
,+ c2y(st) + e(st) [9.3] (1+ p)t [9.4] c(),(.) ? O,4.) < 1 where utilities for andlabor, consumption b(s?)is Uc and Ue aremarginal theinitial stock ofdebt, andprofits areassumed tobe zerobyvirtue ofour toScale (CRS) production use oftheConstant Returns function below. Thesolution inthe tothe is derived tothis problem Appendix paper (cf. fn.7). It amounts toan optimal decision rulefor thetaxrate andinterest on economic world. Morespecifically, publicdebtin thisstochastic political thethree theassumption that random variables independent (z,g,e)takeon eachimplies s takes on(2 x 2 x 2 =) 8 states. twovalues that Theoptimal deis a pair of X andR for rule eachofthese states. Theuseofthese cision eight in thefaceoftherealization oftherespective states minimizes policy pairs in approval thesumoftheexpected deviations from thegovernsquared therepresentative ment's whilesimultaneously households target solving andadhering tothe andcompetitive optimization market problem feasibility laidoutabove.Substantively, constraints ofevents thesequence is that the ofshocks) state is realized, chooses itsoptimal (3-tuple government pairof that thechoiceofoptimal and policies imply, simultaneously, consumption labor aremaximized, andmarkets In inputs bythehousehold, clear. profits thisentire is interpreted thesimulation as one episodeof below, sequence APP(st) a,
c(st )
640
R. Freeman John andDaniel Houser
political-economic equilibration, an episode associated with therealization oftherespective ofshocks. 3-tuple The history ofthepolitical-economic ofthese is the record ofthese system episodes ortheseries equilibrations.
Additional Specification and Parameterization
Theutility function is assumed tohavea standard form; that is,

U(c,l) =
{cl7(1
-
UJ< 1,U ?0
[10]
? is theamount oncemore, ofeffort where, devoted tolabor so 1 - ? is leisure, so-called curvature parameter representing the relative degree v is the ofrisk aversion ofthe representative household, and y represents the weight in relation given to leisure tothat given to consumption. Thisis theutility that function is usedin realbusiness normally cycleresearch. With it,the utilities for marginal consumption andlabor areI2:
UC {C1Y (1 - ?)Y }v
U -{cl-71(I _ ?)7 }NJ-
(1 - 7)c-1 (1 - qY
. c y-7 r . . (1 - f)7-1
Laboreffort is operationalized as thepercentage of available timenetof carethat to work. is devoted sleepandpersonal Following conventional inrealbusiness theavailable practice cycleresearch, time-thehousehold time endowment-each is assumed tobe 1,369hours Chrisquarter (Chari, andKehoe1991;Christiano andEichenbaum tiano, 1990);and,thecurvature we setthe parameter, iv is setequalto-1 and y is setto .66. Finally rate therepresentative in discount for that household, j3,at .99; this implies realquarterly nonstochastic state the is 1%.13 steady equilibrium interest rate
rulefort andR andthen decision adheres tothis rulein all subsequent periods. As regards itsproblem is notreducible to thehousehold, to a seriesoftwo-period a variable optimization problems becausethestate theperiod. spacedoes notinclude representing 12Some oftheresults arederived foran evenmoregeneral ofrealbusiness class cyclestudies ofutility functions (cf.Chari, Christiano, andKehoe 1991).Also,someresearchers makeallowance fortheintertemporal of leisure, forvaluation substitutability morespecifically, of lags of leisure (Kydland and Prescott 1982,esp. 1351; Backus,Kehoe,and Kydland1992, 1993). More complicatedset-ups ofthese kinds willbe evaluated in future research. 13 Thereis little consensus aboutthevaluesof thecurvature parameter. Hence,researchers sometimes foralternative study their models'behaviors valuesofpsi (Chari, andKehoe Christiano, valuethat oftheir 1991) orthey imposea particular thebehavior improves models(Backus,Kehoe, and Kydland 1992). In stillother cases,someoftheparameters areestimated with thegeneralized moment method (Christiano andEichenbaum 1990).We use thevalueof-1 (cf.Backus,Kehoe,and Kydland1992; Prescott1986). The value forgammais usuallyassumedto be .66 because, in a plausible result nonstochastic economic this valueyields for work time ofabout34%. equilibrium, In non-stochastic economic therealquarterly interest rateis approximately equilibrium B-1.
I 'The government choosesa
641
that ourmodel doesnotconfunction, recall Turning totheproduction oflaborinput is a function only. Also,containcapital. Henceproduction 1992;Kydland andPresKehoe, andKydland cepts likeinventory (Backus, forsimplicity, we assumethat the cott1982) are notapplicable. Rather, of has theform y = 0 hencef'(y) = 0WO-1. In terms production function oftheeconomy, [2],we havethen ourstochastic model
y = z(st)(1 + p)tf(t) = z(st)(1 + p)ttO
[2']
assume that the funcproduction Realbusiness theorists typically cycle forexample, constant to scale (CRS). Thisimplies, tionexhibits returns TheCRS assumption factor willexactly double output. that inputs doubling andthat thesetofequilibthat arezeroin equilibrium guarantees profits firm is identical toan in an economy a representative rium with allocations of suchfirms (Hansen1985).We by a largenumber economy populated a CRS proincludes andassume that ourenvironment follow this tradition requires onlylaboras an induction Becauseourtechnology technology. thegrowth theCRS assumption implies0 is equalto 1.0.As regards put, laboris therate ofexogenous, quarterly, factor, (1 + p)t therhoparameter in itis therateat which output grows technological progress; augmenting rate ofgrowth To match theobserved equilibrium. nonstochastic economic in theUnited in ourtime frame ofabout.6% perquarter, we set p States in that is stochastic it is theproduction process equal to .006. Recallthat theseshocks arerepresented by to exogenous technology shocks; subject to similar therandom variable z. Thisrandom variable also hasproperties to Thatis, z is assumed intherealbusiness itscounterpart cycleliterature. Markov chain;z takeson twovalues-one twostate follow a symmetric, oftheform probabilities "low" (1) and one "high"(h); it has transition a paramuntil we found different valuesof7tandof Z1lh with experimented ofUnited States that mimicked production. eterization important properties thestandard deMorespecifically, we found valuesof7tandZlh suchthat model's simulated deviaorder autocorrelations ofthefull viations andfirst weresimilar to HP trends in log-consumption andlog-output tionsfrom time those ofactual United States datainthechosen period (1980-90).The
finalvalues fortheseparameters are forz, we matrix Prob{zt+i= zilzt= Zi} = 7tfori = l,h. Using thistransition
and to that usedin Chari, Christiano, thevaluefor 7tis similar (Notethat Kehoe1991.)14
theBureauofLaborStatistics from worked wereobtained hours perquarter 14Data on average for 2370,March91; estimates U.S. 1909-1990volume1,Bulletin Hours,andEarnings, Employees, intotal primonths for worked byrespective average hours wereconstructed from estimates quarters data is the macroeconomic establishments. The sourceof theReal GNP and other vatenon-farm
t=
= .99, and Zhigh= 1.01. .91, zlow
642
John R. Freeman and Daniel Houser
In Chari, Christiano, andKehoe(1991) andrelated realbusiness cycle studies, government is assumed spending togrow Weassume exponentially. the growth factor is (1 + p)t. Hencewehaveg, = g(l + p)t where Prob{gt+j = gilgt = giI= 0 fori = l,h.As in thecase of ourproduction function, we experimented with alternative valuesoftheparameters until a pawe found rameterization that produced modelsimulations in which thegovernment spending tooutput ratio andstandard deviation andserial correlation ofHP trend log-government matched spending those ofUnited States datain the = .074, ghigh = .078 and 0 = .95.15 chosenperiod.This is thecalibration glow Recallthat ourapproval function, [7],is a simple linear combiadditive nation ofconsumption, labor input, anda stochastic term:
APP(st) = co + a,
(I + p)t
c(st)
+2y(St)+
e(st).
[7]
Ideally, to follow theapproach usedbyrealbusiness cycletheorists, we would parameterize basisofmicrodata. [7] onthe Wewould tiedown thealphacoefficients to micro observations bysubstituting coefficients into[7] that areestimates from thestatistical ofrelevant analysis panels(see Freeman1993;see also Brady1996).Unfortunately, themicro observations refor quired this arenotavailable. TheNES dataon approval for the1972-76 paneldo notcontain questions about consumption andemployment which aresufficiently comparable tothepresent variables. Norarethestatistical estimates one obtains from these paneldataeasytointerpret in relation to
thecoefficients in [7].16
A more heuristic method therefore was used.Somesimple regressions wererun to obtain initial estimates ofthealphas. theMarkov Then, using
Electronic Bulletin BoardoftheNational Technical Information Service(Stimson Macropolity Data Set). The fulldatasetis available uponrequest from theauthors. Again,thetimeperiod was chosento takeintoaccount structural discontinuities in economic policyin thelate 1970s(MillerandRoberds1987) andunusual volatility in approval in early1991 (Jackman 1995,19).Also in theperiod1980-90 thesameparty controlled theWhite House. This fact in theinterpretation figures ofthemodelbelow. 15The samesimulation procedures wereusedto parameterize thegovernment spending component ofthemodelas for theproduction component. All simulations werewritten inMathematica. Thiscode also can be obtained from theauthors. 16The NES panelfor1972,1974,and 1976contains a record ofapproval decisions. However, therespective datahaveto do with personal finances, employment status oftherespondent orofhis or herfamily, andemployment prospects fortheeconomy as a whole.The personal finances questions maybe related to aggregate consumption. Butthere is no question capturing theidea ofhours worked in relation to timeendowment. Also,thecorresponding statistical estimates areofthelogit and it is notclearthat variety, they necessarily as easilyas macroeconomists aggregate claim(cf. Prescott 1986a,1986b:esp. 14).
643
run for momentarily, simulations were described chain for approval shocks HP toobtain simulated Next these alphas wereadjusted these initial values. ofactual HP trend matched those trend series whose properties logapproval of our analysis In thisinitial log approval seriesforthechosenperiod. is a function of normed consumption approval model,we assumed that forct0andcc are values is zero;ourfinal alone. Ourvaluefor?(2 therefore reported below.17 scientists havebegun variable e, while political As regards therandom ofMarkov transition they set-ups (Jackman 1995), toexplore the usefulness forapproval enhancing to/ thetransition probabilities havenotestimated of specified the magnitude diminishing shocks. Norhavethey from approval likeBrody (1991,Table3.1) study ofstandard works suchshocks. However, In particular, the andSmith (1993,Appendix B) is suggestive. andOstrom oftwotheexistence bythese authors suggests historical record constructed inTable2. Generally likethose speakMarkov chains state, nonsymmetric fortransitions from apsimilar probabilities ing,thetwostudies suggest is that Brody's shocks. Where they differ proval enhancing to diminishing forapproval diminishing a somewhat tendency greater record suggests events. Sincethese andrelated byapproval enhancing events tobe followed ofthese events netoftherightworks arenotclearaboutthemagnitudes in thesame in [7], therespective valuesweredetermined handvariables z andg; that e andlowe values manner as for ofthehigh is,themagnitudes series thealphasto create simulated weredetermined approval alongwith for HP detrended likethose theHP detrended, which when hadproperties most matches we series. Sincetheir time frame closely ours, actual approval Therescaled here. parametertransition probabilities usetheOstrom-Smith = -.0135 and ehigh = .0135. Again,in izationis: c0 = -.025, cc = 2.5, eloW that thestochastic this initial ?2 is setto zero.Thisimplies investigation, in approval inthe element ofthepolity shocks which causeshifts produces
rangeof about3%.18
in that semoretheHP trend inApproval is thelong-term component (low frequency) 17Once shifts in support forthe as generational itcorresponds to suchthings ries,Cf. fn.7. Substantively, in output. Creating aretiedto theHP trend shifts whichconceivably institution of thepresidency, in thetime frame ofthetwotheois important hereto achieve comparability sucha decomposition (1994). ries.See Freeman andStimson of conof theshocksin Brodyare notnetof theeffects thereported magnitudes 18Clearly, theirs is simply oftheshocks; Nordo Ostrom andSmith offer anymeasure sumption and(or)labor. A simple of regression during theReaganyears. a listofapproval enhancing anddiminishing events significant positive produced a statistically consumption forthechosenperiod approval on normed coefficients were ao = -106.49 between thetwovariables. The unscaledregression correlation signof (X is conR2 of .54. The positive equation had a corrected and a1 = 3.27. The respective for inmaterial welltheconventional that reward increases citizens government sistent with wisdom someexperimentation we settled on scaledvaluesof cxo= -.025 and al After beingandviceversa.
644
Table2. Implied TwoState, Nonsymmetric MarkovChainsBetween Approval Diminishing (-) and Approval Enhancing (+) Events
Table 2.1 BRODY (1947-86) t+ 1
_
Table 2.2 OSTROM & SMITH (1981-88) t+ 1

-
Table 2.3 BRODY (1964-86) t+ 1

-
t +
.32 .68 .38 .62
t +
.50 .50 .36 .64
t +
.33 .67 .45 .55
inthe Several remain parameters tobe specified. As explained Appendix to ourpaper(Cf. fn.7) oursolution to thePolitical Motivated Allocation abovethis that means is slightly ,B= .988,orthat more government myopic than For ourinitial households. we setAPP* equal to a value analysis, to a "minimum of .55. In other roughly equivalent winning" target words, we initially coalition and other assume, following branches ofpolitical that seeks tomaintain theory, government thus majority support maximizing the tothe ofwhich itis composed. this gains groups as(Werelax particular in thecounterfactual s represents the sumption analyses Recallthat below.) oftheproductivity, jointrealization government and approval spending, and ri denotes the transition between thestates. Treatshocks, probabilities as independent, shocks thetransition from ingthese our using probabilities 19 Markov chains, anddefining s as before we have: .43225 .04275-~.43225 .04275 .00275 .00225 .02275 .00225 S2 .04275 .43225 .04275 .43225 .00225 .02275 .00225 .02275 S3 .31122 .03078 .55328 .05472 .01638 .00162 .02912 .00288 S4 .03078 .31122 .05472 .55328 .00162 .01638 .00288 .02912 S5 .02275 .00225 .02275 .00225 .43225 .04275 .43225 .04275 S6 .00225 .02275 .00225 .02275 .04275 .43225 .04275 .43225 S7 .01638 .00162 .02912 .00288 .31122 .03078 .55328 .05472 S8 .00162 .01638 .00288 .02912 .03078 .31122 .05472 .55328
SI = 2.5. This parameterization produced fortheindependent Ostrom and Smithtransition matrix, simulated approval serieswhoseHP trend-log valuesmimicked thoseoftheHP trend-log ofactual inthe1980-90period. approval series Also,all simulated approval valueswereintheinterval [0,1]. '9Thevaluesin the Hl matrix are rounded to fivedecimalplaces.Recall that s is defined in terms of thejointrealization of thethree shocks, s = (z,g,e).So, forexample, with thesymmetric Markovchainsfortechnology and government spending shocksand thenonsymmetric Markov chainderived from theOstrom-Smith data for1981-88, theprobability forthetransition from SI(Z1ow, elow)to S2(Zhigh,ghigh,ehigh)is .09 X .05 x .50 = .00225. glow, S4 S2 S3 S4 S5 S6 S7 S8
Problemrequiresthat
,(i + p)(lY)'.
Withthe parameters described
645
intheinitial Finally, thereturn on inherited debt state, R(sl), andtheinheritedlevelofinherited debt, b(sO), areboth settoone.And,initial assets, A, aresetto2.0.20 Theright-hand panelofTable3 reports theparameters for thebaseline model. Thefourth andfifth columns ofTable4 report the corresponding optimal in thispolitical policyrule;that is, howgovernment responds economic world tothe joint realization ofthe respective setsofproductivity (z), public spending (g),andapproval Forexample, the (e) shocks. optimal decisionruleimplies that when S8 (Zhigh, ehigh) obtains, public authorities ghigh, a taxrate adopt of.304(row8 ofTable4). Incontrast, when faced with S6high productivity andhigh government spending shocks but an approval dilower of.281.Thisis because, ceteris taxesareneeded toencourparibus, increase andhence increase age more work, consumption, approval (in the in that Thenegative realinterest faceofa surprise decrease rate variable). inthese reflects the needfor lessborrowing from households circumstances. theeight Together a contingency pairsofpoliciesconstitute planwhich in minimizes government's discounted deviations from expected itstarget, the baseline case,55% approval.2' 1 displays Figure theresults ofa single simulation ofthis model. The solidlinesinthefigure aretheHP trends. Eachtime oneof point represents In this ourpolitical-economic taxandinequilibria.22 particular simulation,
that 20Recall R(sl)b(sO)is defined as thereturn on inherited debtin theinitial state, s1. One A as capturing is abouteight couldthink oftheparameter thefactthat consumer netwealth times Butthevaluesofthis annual income. andofR(sl) andb(sO)usually areadjusted for parameter comandKehoe 1991. putational purposes. Cf.Chari, Christiano, 2lInsofar as interest ratesare concerned, recallthat households also optimize subjectto the itsexogenously transition forthedifferent states determatrix and thatgovernment mustfinance minedspending stream. The eightinterest ratesensurethatboththings happensimultaneously. in making Households takethegovernment's interest ratesintoaccount and optimal consumption their laborinput choiceswhich maximize expected rateof return givenH. And given thesehousetheoptimal interest rates(together with theoptimal taxrates) holdchoicesandthespending path, allowgovernment tominimize theexpected sumofapproval deviations andalso tofinance its target werelinear, thenegative spending. (Ifwe wereanalyzing a steady-state, orifourutility function real interest rates might be counter intuitive. However, in ourset-up, themarginal utility ofconsumption is stochastic. thehouseis decreasing andtheenvironment Therefore there willbe a point at which to save fortomorrow, rather itis possiblethat holdprefers than consume moretoday[eventhough thefuture willbe negative]. thenegative is as "storreturn Another waytointerpret realinterest rates age costs."Evenin thepresence of uniformly positive storage costs[always negative there returns] willbe a point at which a maximizing willprefer consumer to paythecostandconsume tomorrow rather than accruethevery low marginal utility ofconsuming today.) in each of the 1,000simulations. 22Inall, 200 observations wereproduced The first 156 of in theFigure1. The idea of a setheseobservations weredeletedleaving44 likethosedepicted is akintothat quenceofpolitical-economic equilibria which Prescott (1986a, 13) callsa sequence of market equilibria.
minishing shock(row 6 of theTable), government chooses a lowertax rate
646
JohnR. Freeman and Daniel Houser
Table3. BaselineParameterization
Parameter p Value 0.006 0.990 0.988 0.660 1.000 -1.000 -0.025 2.500 0.550 1.000 1.000 2.000 0.990 1.010 0.950 0.050 0.950 0.050 0.074 0.078 0.910 0.090 0.910 0.090 -0.014 0.014 0.500 0.500 0.640 0.360
0 v ocO ocl APP* b(0) R(1) A Shock Technology Low High Probabilities: Transition Low to Low Low to High High to High High to Low Gov SpendingShock Low High Transition Probabilities Low to Low Low to High High to High High to Low ApprovalShock Low High Transition Probabilities: Low to Low Low to High High to High High to Low
9 H
.-t
- -i
R
H C t~~~~~~~~~~~~~\ \c \c n5
--4 cn
--
ON\ ~~~ =~~~~~~~~~~~~~r

C,\m
kn
c' CQ~~~~~~~~~~~~~~~~c
ooo ci
ci
c;
r-
*) t-C
nn l C )
<
Cl o
C,
Cl
-\
/ a)
oCo o~~~~~~~~kr
o
a
f3 r
CS S
O
Y
Q r)C 0 U
'
lCl
' 6666o
0l
lC 400
Cl 4
o6666o
o
PC ^
~ ~o ~ > > o
Cl 0z
ClV
.) .N
-O 0
.N
'o OO0
OO
=~~
1s t 0
?~~~
z~~~-
34 3Zm.m33.
648
andDaniel Houser John R. Freeman
BaselineParameterization with Figure1. A SingleSimulation

0.310 0. 0.300
Tax Rate
. . ..
0.10 -
Interest Rate
... -.. ....
0.305.... ... .... ...
...-
.
..
... .. ... ..
0.05
a
E-0.280 0.2900.270
....................... . 0.295..
Cd ....
. . . . . . 11111111111111
-0.05..
U)
0.10-0
lllllllllliiiiiiiiil
80
81
:1
:::: 82 83
84
85
Year
86
87
:: 88
89
90
0.10
80
:1: 81
82
83
84
85
Year
i 86
87
:1:::_+H ..... 88 89 90
1.00 -
Debt
><
-. .0.6....
0.34
Consumption
..
0.80
0
--------- ----- ---------~~~~~~~~~~~~~~~~~~~~0.30
0.0 00;
L
1 82 83 84 85 86 87 88 89 0
0.26
..........
......................
808
Year
8081
82
83 84 85 86 87 88 89 90 Year
0.61
Approval
0.60
0.58
80
81
?"|??l
82
83
H H H ?|??H ii8| 84 85 86 87
Year
H ... i i lllll 88 89 90
fall.Debtsteadily decreases. terest riseandthen rates slowly Consumption is maintained within whileapproval All thisoccurs increases as expected. 5% ofthegovernment's approximately target. themodelmimics theUnited Fortheoverall setof 1,000simulations, HP trend inacfrom States datarather well(Table5). Thedeviations actual havesimiandgovernment tualandsimulated logconsumption expenditure inHP trend inthe Thesameis true ofthedeviations larstandard deviations. for deorder The first autocorrelations andthesimulated actual log output. andofapproval ofthelog ofgovernment viations in HP trend expenditure
649
Table5. The BaselineModeland theData

Variable Log Consumption** Log Government Expenditure** Log Approval** Log Output** Government Expenditure to Output Ratio StandardDeviation* Actual 0.011 0.013 0.063 0.015 0.233 Model 0.011 (0.001) 0.017 (0.004) 0.012
(0.001)
Serial Correlation* Actual 0.755 0.464 0.855 0.798 Model 0.122 (0.156) 0.575 (0.156) 0.971
(0.005)
0.008 (0.001) 0.235 (0.003)
0.012 (0.152)
arein simulations. standard deviations *Statistics formodelbased on 1,000,44 quarter Empirical in rownineareactualratios. parentheses. Figures **Deviation from Hodrick-Prescott trend.
for dataas well.Theratio ofgovernment expenditure match those theactual to output is thesamein theactual andsimulated data.Theonlydiscrepanofthedeviations HP trend correlations from in log concies aretheserial is in inthe there more the actual data persistence than sumption andoutput; the the "obsimulated for these model But, overall, explains data variables. thedecomposition of applying methods jective facts" which emerge from realbusiness cycle theory. is provided ofthe ofthe model bysimulation Further evidence adequacy for without to results labor Themodel wasparameterized anyattempt input. ofthesimulated series ofthe labor input tothose actual match the properties final wasdecided, this hours. Oncethe datafor comparison parameterization In simulations theactual and wasmade. Theresults were reassuring. 10,000 of in log hours well.The standard deviation simulated HP trends matched in the and .00810 inloghours was .00717for actual data theHP deviations of of our Thisis independent confirmation theadequacy thesimulated data. model inthesample period.23
tomimic actuallaborinput datawas ofthemodelinterms ofitsability 23Again, theevaluation ofpolitical an additional was decided. Fromthestandpoint science, doneafter theparameterization and Smith approval dataforunitroots(e.g.,Ostrom confirmation might be to checkthesimulated of approval management, the as a consequence of thewaywe conceive 1993). However, notethat ofvalues(Figure1). Hencesucha checkis a smallnumber respective seriessimply jumpsbetween notmeaningful.
650
lies in what ittellsus about suchas this Thevalueofan investigation model allowsus to The baseline counterfactuals. significant theoretically features of the economy political the ofvarious structural importance gauge set-ups likeVARs and form are notpossiblewithreduced in waysthat Kehoe1992: Kydland, 1993;cf.alsoBackus, example (Freeman ECMs,for inthis here two questions of substantial examining Weshow by esp.765ff). do with The first has to the ofAmerican economy. political terest tostudents The impact of on policy choiceandwelfare. volatility impact ofapproval bear is the second. these inquiries Together consensus building presidential is compatible with ofwhether accountability political onthelarger question market processes.
ApprovalVolatility
Analyses Counterfactual
is subject tounexpected, seemthat There is much approval agreement events areinternational oftheseshocks And,many random shocks. ingly economic models and Smith 1993).24The political (Brody1991;Ostrom include variables that capture areusedto study management that approval andRosenthal 1993, Londregan, Alesina, theseshocks (cf.,forexample, the of approval these consequences analyze none of investigations 20). But ofinternational is goodreason to do so: thenature perse. There volatility forsuchshocks-andfor is rapidly andtheprospects relations changing ofthe world a defining feature present ofincreasing shocks magnitudes-is have witnessed more violent inter1990s Forexample, the already system. world conflicts that decade since the second conflicts than war, national any of war" a "transformation (Gantzel character constitute non-state bytheir and Siegelberg 1994; van and Schwinghammer Schlitche, 1994; Jung, is thereconflicts States involvement in international United 1991). Creveld, to continue to produce butalso apshocks, fore notonlylikely approval willtheincreased Whatimpact shocksofincreasing magnitudes. proval What volaine haveonpolitical-economic equilibrium? doessuch volatility What to achieve its mean for the ofgovernment target? approval ability tility ofsuchefforts? arethewelfare consequences themodelwith the This counterfactual was studied by reanalyzing by shocks increased byabout220%,morespecifically, ofapproval range = = + new decision rules for this countersetting el.w -.03 andehigh .03.The that theoptimal arereported in columns 6 and7 ofTable4. Notice factual For for the baseline case. the larger aptaxrates aredifferent from those
of Table2.3 is based,abouttwothirds andSmith dataon which in theOstrom 24For example, In thecase oftheBrodydata(1991: Table3.1) events. shocksaredue to international theapproval in character. areinternational all theevents
651
proval diminishing shocks, thetaxrates arelower; forthelarger apelow, proval enhancing shocks, thetaxrates arehigher. Therange oftheinehigh, is larger terest rates inthecase ofgreater approval volatility as well.Why is this so? Consider thecase ofthelarger, approval diminishing shocks. These shocks lead governments to lower taxrates to encourage a comparatively greater amount of work. Thiscreates moreoutput andconsumption and hence a greater, in approval. offsetting increase Becausethere is more outis lessneedfor put, there borrowing tofinance theexogenously determined, government spending levels.So interest rates arecomparatively lower. The is true for converse the larger approval shocks associated with the high volatility case. Figure3 depicts a singlesimulation forthehighapproval volatility tothe counterfactual. To establish comparability baseline case,thesameseis usedthat intheface quence ofstates produced Figure 1. First, notice that ofgreater ine government hasmore itstarget. volatility difficulty achieving Within five tosixyears, levelofapproval is about the 6% above the.55value. As regards theeconomic variables, taxandinterest rates behave as before, andthen Debtagain decreases while rising slowly falling. steadily consump1 suggests tion increases. then that steadily Figure higher approval volatility may not havea substantial impact onpolitical-economic equilibration. ofthecounterfactual Closerstudy modelreveals however. otherwise, Simulation ofit (Table6) shows that sohigh approval volatility produces harmful in certain In particufluctuations macroeconomic variables. cially thestandard ofdeviations HP trends deviation from inlogconsumption lar, andlog output aredoublethose for thebaseline case.As a result, thewelfare oftherepresentative household is slightly lower in thecounterfactual. To be specific, in the abouta .01% drop high approval volatility produces In thisway, welfare oftherepresentative household.25 theanalysis shows in that "business important cycles phenomena" (Lucas 1987)canbe traced, togovernment in an increasingly volatile part, approval maintenance international polity.
Who "Love Dangerously" Presidents
is Thebaseline modelassumed that strive to create what governments a minimum coalition of55% approval. Butsome essentially winning governments strive for more than for consensual support this, presumably excessive, levelsofsupport. Thesegovernments arecriticized for often tooatbeing tached to their andhencefor"Loving approval rating Dangerously" (The
25 The welfare oftherepresentative consumer is calculated byevaluating itsobjective function in thesimulations, at each morespecifically, by summing itsrealized,discounted present utility point in time.
652
Figure 2. A SingleSimulation with HighApproval Shocks

0.32
Tax Rate
....QQ
1
0.15
Interest Rate
0.30
0.28.............
cO0.29
co0.28 0.27 . 1.
-0.05
.0..
...
.
....
-1
......i ..
......
..
-0
1
. .. .. .. .... ....... ........ .. .. .... .. 1 ..... ............. .....i .. -15 . :-.. 1 -* .
....... .
- \0.10..
0.26
~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
....................................-.5..........
............................. ..
.0.1....
...
80
81
82
83
84
85
86
Year
87
88
89
90
80
81
82
83
84
85
86
87
88
Year
89
90
1.00 0.80 0.60 0.40 . -
Debt
.................................................. >..------....................................... . _........................................ . *
0.34
Consumption
* ..-------------......----- -------
0.32 .0 3
- -----_--
5w 02..................... -0 2?0? ....-0 40 .. . . . .. . . .
~~~~~~~~~~~~~~~~~~~~0.20
... . ................. .. . .0 1 2
.....
............
..........................E
26
..
..
..
-0.60 -0.80 80 81 82
........................ 83 84 85 86 87 88 89 90 0.26 80
Iliilliilliillllliilliillii
81 82 83 84 85 86
Year
Year
87
88
89
90
0.620
Approval
.. ...............
...... .. W iv
,, ,..,
0.610
co0.600
0.590 -lll
0.58 V...
lll
,.............r .. .
------li
TT rX ||
iil
80
81
82
83
84
85
Year
86
87
88
89
90
Economist January 24, 1991,21-4). Whatis theconsequenceof suchbehavior?Is consensus building sociallyharmful? If so, in whatway? This counterfactual was studied APP* equal to .70 rather by setting than to thebaselinevalue of .55.26 Theresulting decision ruleis reported incol26Forthis A wasreset counterfactual to-3.25. Technically, this was donefor computational reasons(cf.fn.20). Substantively, itmeanstherepresentative household was assumed initially to hold personal debt roughly ninetimes itsincome. In relation toourdesign, this revised valueofA provides a stringent evaluation oftheLoving Dangerously argument-an assessment ofwhether a society with a largeinitial levelofindebtedness can afford a president whostrives for political consensus.
653
Table6. LargeApproval Shocksand BaselineModels

Variable Log Consumption** Log Government Expenditure** Log Approval** Log Output** Government Expenditure to Output Ratio StandardDeviation* L.A.S. 0.021 (0.001) 0.017 (0.004) 0.026 (0.001) 0.016 (0.001) 0.235 (0.003) Baseline 0.011 (0.001) 0.017 (0.004) 0.012 (0.001) 0.008 (0.001) 0.235 (0.003) Serial Correlation* L.A.S. 0.044 (0.152) 0.575 (0.156) 0.971 (0.005) 0.048 (0.150) Baseline 0.122 (0.156) 0.575 (0.156) 0.971 (0.005) 0.012 (0.152)
44 quarter *Statistics basedon 1,000, simulations. standard deviations areinparentheses. Empirical Figures in rownineareactualratios. **Deviation from Hodrick-Prescott trend.
umns 8 and9 ofTable4. The indications arethat fora target of70% approval governments adopt much lower taxrates anda wider ofinterest range inthe rates than baseline case.In terms ofourmodel, thelower taxrates ento work. in courage households Thisincreases andconsumption; output turn, approval is augmented. Forexample, for thestate oflowproductivity andlow government shocks andapproval shocks diminishing (sl), thetax rate nowis .123as compared tothe baseline taxrate of.272.Inthe high productivity andgovernment expenditure shocks andapproval shock enhancing state is only.171for thecounterfactual whereas thecorre(S8),thetaxrate ratewas .304 in thebaseline. sponding to thesolution, According adjustments areneeded intheinterest rates for thedifferent states toenablegovernment tofinance itsspending inthefaceofthis newtaxschedule (fn. 21). Figure 3 reports the results ofthe for this model. comparable simulation Notethat in achieving in this is more successful itsobjective government case.Approval incongetswithin 1% ofthehigher value.Thetrend target indebt thetrend is increassumption againis increasing. But, interestingly, ofthe ingas well.Inthis the hasa difrespect, pursuit higher approval target ferent thanthepursuit of theminimum impacton themacroeconomy winning approval target. Theresults ofthe1,000 simulations ofthis second counterfactual model arereported inTable7. They ofthehigher indicate that thepursuit approval target (H.A.T.)hasno substantial effect onthe ofconsumption and volatility ofoutput. inHP trend Deviations logconsumption andinHP trend logouthaveessentially the put samestandard deviations as inthe baseline case.The
654
Target with HighApproval 3. A SingleSimulation Figure

0.18
Tax Rate
0.10
Rate Interest
.. .
0.05
ooi 0.17 ... . . . . . . . . . . . . : - - - IIV-1-
....L\ -----..... ... .. -~0.16-.lo. 0.15
co
. ...... .......
0.00 C4~~~~~~~~~~~~
U)~~~~~~~~~0.1
80 81 82 83 84 85 86 87 88 89 90 Year
80 81 82 83 84 85 86 87 88 89 90 Year
Debt
3.00
.......................................< 2.50. .7.
Consumption
.;< ;0.38 0.36.. .,Y....... ...... . . . .. . . . .
1.50 -.-- - -- - - -- - -
------
.............
. .
0.2
0 32 . . . . . . . . .
... . . . . . . .
80
81
82
83
84
85
Year
86
87
88
89
90
80
81
82
83
84
85
Year
86
87
88 89.
0.69-
Approval
. ... . .. . . . . . . . .
0.69 .. .
0.68
0.67 Ii
80
ilW ii;
81 82 83
i;; l
84 85
--.......... .............---. ........111il

86 87 88 89 90
Year
different. The main in thesedeviations areslightly ofpersistence degrees to output. Theaverage difference is intheratio ofgovernment expenditure ofthehigh for thesimulations valueofthis lower approval ratio is slightly tooutratio ofgovernment spending model. this lower average Again, target than As for welfare rather with shortfalls surpluses. budget putis associated therepresentative in thehighapproval simulations target consequences, inthebaseline than is 7-8% higher household's discounted utility expected
655
Table 7. High Approval Targetand Baseline Models

Variable Log Consumption** Log Government Expenditure** Log Approval** Log Output** Government Expenditure to Output Ratio StandardDeviation* 0.013 (0.001) 0.017 (0.004) 0.006 (0.001) 0.010 (0.001) 0.213 (0.002) Serial Correlation* 0.067 (0.150) 0.575 (0.156) 0.970 (0.006) 0.079 (0.150)
H.A.T
Baseline
0.011 (0.001) 0.017 (0.004) 0.012 (0.001) 0.008 (0.001) 0.235 (0.003)
H.A.T
Baseline
0.122 (0.156)
0.575 (0.156) 0.971 (0.152) 0.012 (0.152)
areinparentheses. 44 quarter simulations. standard deviations *Statistics basedon 1,000, Empirical in rownineareactualratios. Figures from Hodrick-Prescott trend. **Deviation
are thatforthelivinggeneration at least,"Loving case. So theindications of nearconsensualapprovaltargets-is pursuit Dangerously"-presidential notsociallyharmful. Conclusion the As a means of connectingeconomic and political equilibration, Firstand foremost it achievesa genumodelin thispaperhas manyvirtues. The model fusesa generalequilibrium economy ine theoretical synthesis. witha rational, householdto an approval-oriented politywitha optimizing than It thusis morebalancedand complete rational, optimizing government. forthefirst In addition, time,we have a political manyof its counterparts. monthly) equilieconomicset-upwhichexplainsquarterly (and potentially that in theliterature, ourmodeldoes not imply bration. Unlikeothers equilibrationoccurs only everyseveral years,e.g., thatthe political economic it is muchmorerealistic world"starts overeveryfour years."In thisregard, thestochastic natures ofeconomicand anduseful thanitscompetitors. Third, in ouranalysis. The constraints incorporated political processesareexpressly for variables or"laws ofeconomicandpolitical motion" includerandom proand approvalshocks and, concomitantly, spending, ductivity, government is a meththeinvestigation optimization. Finally, agentsengagein stochastic odological advance. The analysesof theformalmodel and of the data are ofthemodelare interpreted elements consistent. For example, thestochastic in thesamewayin thederivation oftheagents'optimal decisionruleas in the
656
has The investigation thus analysis. simulation, and statistical decomposition, call of answering Bartels'sand Brady's(1993) and others' theadded payoff andpoliticalmethodology.27 theory fora better marriage of formal of ways. Like the Of course the model can be improvedin a number (1993, 14) and earlycontribuformalism and Rosenthal Alesina,Londregan, tionsto thereal businesscycle genre(Lucas and Stokey1983), it does not of labor input.Among other include capital. Outputis solely a function More comcontent of themodel.28 things, thisweakenstheintertemporal that X2 = 0 oughtto be studied;the assumption plex approvalfunctions consumption oughtto be relaxedso thatapprovaldependson bothnormed is disembodied insoourapprovalfunction More generally, and laborinput. to household decision-making. We faras it is not connectedanalytically and level of work need a set-upin whichhouseholdschoose consumption What we have now is esseneffort and dispenseapprovalsimultaneously. approvalfuncrather thana fully rationalized tiallyan approvaltechnology in our set-up. difforheterogeneity Clearly, tion.Thereis also no provision ferent typesof householdsmakeeconomicand politicalchoices differently. ofconstituents of some subsets caremoreabouttheapproval And presidents somehow. This needsto be incorporated thanthatof other subsets. The polityin the model could be enrichedin otherways. At present, ofpowersamongdifferent fortheseparation there is obviously no provision thateconomic policyor forelections.To the extent political institutions can be tracedmoreto theexecutivethanto thereof makingand theeffects and Rosenthal1993, 13) and the thelegislative branch (Alesina,Londregan, objective factswithwhich we are concernedhave to do withmacroeconomictrends, theformer is not serious.Nor is it clear thatthe absence of thatthepresent to remember It is important electoral forcesis problematic. at least theAmerican politicaleconomy modeldoes quitewell in mimicking without Table 5 showsthat, anyproin thevirtual era we study. singleparty consistent decomofthe 1980s,whena theoretically visionfortheelections position method is employed, the behavior of our political-economy is no evidenceof anyelectoral thatof theUnitedStates.Also there matches in approval;forinstance, term fluctuations in theshort and medium pattern trend arebelow,above,androughly equal to thelong-term thesefluctuations
(1993, elsewhere. See Freeman contribution is explained 27The of thismethodological nature 1995). condiwillcreate an arbitrage totheproduction function things, adding capital 28Among other this itsspending. Ofcourse, rate tofinance government's ability touse theinterest tion that willlimit speaking, investment. Practically in themodelwillalso introduce decision variable: another change Cf. Chari methods. of evenmorecomplexsolution theapplication addingcapitalwill necessitate andKehoe(1991,esp. fn.2). Christiano,
657
inapproval indifferent A-2inthe election years (cf.Figure Appendix toour for paper; cf.fn. 7). Provisions electoral forces eventually ought tobe made; ofallowing for theusefulness APP*tovary over time tobe instance, ought explored. But,itmaywellbe that thepolitical accountability that is most important forthestudy ofdemocracy andmarkets occurs, overthelongsomeconnection between lowfrequency in economic through trends term, andpolitical theHP filter variables likethose which captures and,over the short andmedium ofapproval andrelated terms, through surveys popular ofgovernment, Fievaluations notthrough what areinfrequent elections.29 can be useful theclaimthat nally, unitary agentset-ups notwithstanding andSwistak is very (Lalman, Oppenheimer, 1993,80),there little basisfor inthe this ofourmodel. ofparaspect Incorporating differences preferences ifwe want tiesandadministrations therefore seemsessential, to especially it across eras.In this context analyze political-economic equilibria partisan be madefor theendogeneity ofapproval, is essential that provision particuin terms of legislative larlyforthereturns whichaccrueto presidents oftheir outcomes (policy) byvirtue approval rating. tobe dedicated. It is notcleartoexactly which tasks future work ought tothe model andallowing for someheterogeSimply adding capital present ofhouseholds creates sometechnical Yettheseare the neity challenges. insofar natural next steps as theeconomic part ofthemodelis concerned. a set-up in this context households chooseconsumpDeveloping whereby labor andapproval andapproval retion, input, simultaneously yields policy turns is also a challenging task. Thisis necessary, toachieve a bethowever, ter between economics andpolitical science. Thenext then is synthesis step inthese ifourfindings tomodify the model andtodetermine about the ways holdup.It is conceiveffects ofapproval andconsensus volatility building ofpolitiablethat such willaddnot augmentations justtoourunderstanding butofmacroeconomic cal reality as well.30 reality of theAJPSworkshop, In thespirit thepresent effort has laid the for these extensions. Ithasshown howa theoretically groundwork balanced,
29Toreiterate, itis common in approval studies tofocuson a single eraas party/administrative we have(e.g.,Ostrom and Smith 1993).And,whileearly works suchas thoseofNordhaus (1975), Tufte (1978), andHibbs(1977) claimed that elections hadmarked andlasting effects on themacroeconomy, thecurrent thinking (Alesina 1988) holdsthat theseeffects are minor and shortoften orno uncertainty lived.Thisis especially true if,as is usually thecase, there is little aboutwhowill wintheelection. We areindebted toMichaelAlvarez for thepoint aboutthepossibleconnection bein approval tween lowfrequencies trends andin macroeconomic variables likegrowth. 30it that intorealbusiness shouldbe true by introducing political elements cyclemodelsthe ofthoseset-ups willimprove. Forinstance, thelow variability oflaborproductivity in performance thesemodelsmight be a result ofthefailure to consider thepolitical correlates offiscalshocks. Cf. McGrattan, (1994).
658
temporally disaggregated, genuinely stochastic, and methodologically coherent political-economic model can be built.And it has introduced a new and improved conception ofpolitical-economic equilibrium. 16 February submitted 1996. Manuscript Final manuscript received10 March 1997.
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Durr, Robert. 1993. "AnEssay on Cointegration andError Correction Models."In Political Analysis,ed. John R. Freeman. AnnArbor, MI: The University ofMichigan Press.. Freeman, John R. 1993."TheSearchers I: Specification Uncertainty intheStudy ofMacropolitics." Presented attheannual summer meeting ofthePolitical Methodology Society, Tallahassee. Freeman, John R. 1995. "BridgeBuildingPartOne: Toward A Computable PoliticalEconomic Equilibrium Model."Presented at theannual meeting oftheAmerican Political ScienceAssociation, Chicago. Freeman, John R., andJames Stimson. 1994."Decomposition, Causal Inference andTheory Building."Presented at theannualsummer meeting ofthePolitical Methodology Society, Madison. NachDem Zweiten 1945 Gantzel, Klaus,andTorsten Schwinghammer. 1994.Die Kriege Weltkrieg Bis 1992.Munster. LitVerlag. Hansen,GaryD. 1985."Indivisible LaborandtheBusinessCycle," Journal ofMonetary Economics 16: 309-27. ofCalibration." JourHansen, Lars Peter, andJames Heckman. 1996. "TheEmpirical Foundations nal ofEconomic Perspectives 10:87-104. andMacroeconomic American Political Science Hibbs,Douglas,Jr. 1977."Political Parties Policy." Review 71:1467-87. in Spatial TheMedianVoter Result is anArtifact." JourHinich, Melvin.1977."Equilibrium Voting: nal ofEconomic Theory 16:208-19. Robert U.S. BusinessCycles:An Empirical Hodrick, J.,andEdwardC. Prescott. 1980. "Post-War PA: Carnegie MellonUniversity. Investigation." Carnegie-Mellon Working Paper. Pittsburgh, Simon.1995."Re-Thinking Presidential ErrorJackman, Equilibrium Approval: Markov-Switching Presented atthe12th annual Political Summer Indiana Correction." Methodology Conference, University. A NewHandbook Jackson, John. 1995."Political Methodology: An Overview." ofPolitical Science. UK: Oxford Press. Oxford, University Klaus Schlichte, andJens WarsandTheir Jung, Dietrich, Siegelberg. 1994."Ongoing Explanation." ofHamburg. Unpublished manuscript. Hamburg: University in a Positive of Stagnation Rfos-Rull. Interests Krusell, Per,andJose-Victor 1996. "Vested Theory andGrowth." Review Studies ofEconomic 63:301-29. andJose-Victor Rios-Rull.1994. "Politico-Equilibrium andEcoKrusell, Per,Vincenzo Quadrini, in Economics nomicGrowth." CARESS Working Center for Research Paper#9441. Analytic ofPennsylvania.. andtheSocial Sciences, PA: University Philadelphia, andJos6-Vfctor TaxesReally Krusell, Per, Vincenzo Quadrini, Rios-Rull. 1996. "AreConsumption Better ThanIncomeTaxes?"Journal Economics 37:375-503. ofMonetary Fluctuations." Kydland, FinnE., and EdwardC. Prescott. 1982. "Time to Build and Aggregate Econometrica 50:1345-70. 1990. "BusinessCycles: Real Facts and a Monetary Myth." Kydland, Finn,and E. C. Prescott. Review14:3-18. Quarterly An Econometric 1996. "A Computational Kydland, Finn,and EdwardC. Prescott. Experiment: Tool."Journal 10:69-85. ofEconomic Perspectives A and PiotrSwistak.1993. "FormalRationalChoice Theory: Lalman,David, JoeOppenheimer, Cumulative Science."In PoliticalScience: TheStateoftheDisciplineII, ed. A. W. Finifter. DC: A.P.S.A. Washington, in BusinessCycle Theory." Journal 1980. "Methodsand Problems Lucas, Robert Jr., ofMoney, and Banking Credit 12:696-715. Oxford: Basil Blackwell, Ltd. Jr. 1987.ModelsofBusinessCycles. Lucas, Robert, and NancyL. Stokey.1983. "OptimalFiscal and Monetary Lucus, RobertE., Jr., Policy in an Economics Without Journal 12:55-93.3. Economy Capital." ofMonetary
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MacKuen,Michael,Robert Erikson, andJames Stimson. 1992. "Peasants or Bankers? TheAmerican Electorate andtheU.S. Economy." American Political ScienceReview 86:597-611. McGrattan, Ellen R. 1994. "A Progress Reporton Business Cycle Models." Quarterly Review Fall:2-16. Miller, Preston J.,andWilliam Roberds. 1987.TheQuantitative Significance oftheLucas Critique. Reserve BankofMinneapolis. Staff 109.Minneapolis: Federal Report andAll That:An Expository Nickell, Stephen. 1985. "Error Correction, Partial Adjustment Note." Bulletin and Statistics Oxford ofEconomics 47:119-29. Nordhaus, William. 1975."ThePolitical BusinessCycle."Review Studies ofEconomic 42: 169-90. and Renee Smith.1993. "Error Ostrom, Charles, Attitude and Executive Correction, Persistence, A Behavioral Rewards andPunishments: ofPresidential In Political Theory Approval." AnalyR. Freeman. AnnArbor: ofMichigan Press. sis,ed. John University EdwardC. 1986a. "Theory Ahead of BusinessCycle Measurement." Prescott, Review Quarterly 10:9-22. Edward Prescott, C. 1986b."Response to a Skeptic Review10:28-33. [Summers]." Quarterly EdwardC. 1991. "Real BusinessCycle Theory: Prescott, WhatHave We Learned?"Revistade Andlisis Economico 6:3-19. Rogoff, Kenneth, andAnneSibert. 1988."Elections andMacroeconomic PolicyCycles." Review of Economic Studies 55:1-16. Kenneth A. 1995. "The Politics of thePolitical BusinessCycle."British Schultz, Journal ofPolitical Science25:79-99. A. 1996."Macroeconomics andMethodology." Sims,Christopher Journal ofEconomic Perspectives 10:105-20. E. Lucas with EdwardC. Prescott. Stokey, NancyL., andRobert 1989.Recursive Methods in Economic MA: Harvard Dynamics. Cambridge, Press. University Edward.1978. ThePoliticalControl Tufte, of theEconomy. NJ:Princeton Princeton, University Press. vanCreveld, Martin. 1991.TheTransformation NewYork: The FreePress. ofWar. vanderPloeg,Frederick. andRe-Election 1984."Government Efforts." Ideology Oxford Economic Papers36:213-31. vanderPloeg,Frederick. 1987."Optimal Government with RatioPolicyina SmallOpenEconomy nal Expectations andUncertain Election Outcomes." International Economic Review 28:46991. John T. 1990."ThePolitical ofMacroeconomic Williams, Manipulation Policy." American Political ScienceReview 84: 767-96.

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A Computable Equilibrium Model for the Study of Political Economy Author(s): John R.

A Computable Equilibrium Model fortheStudy ofPolitical Economy*

A COMPUTABLE EQUILIBRIUM MODEL

and Daniel Houser John R. Freeman

John R. Freeman andDaniel Houser

A COMPUTABLE EQUILIBRIUM MODEL

and Daniel Houser John R. Freeman

A COMPUTABLE EQUILIBRIUM MODEL

and Daniel Houser John R. Freeman

T(sl))w(slr)?(sl) + V(sl) + R(sl)b(sO) + A

c(st) + b(st) < (I - t(st))w(st)t~(st)+ R(st)b(st-l) + V(st) t = 2, 3,

A COMPUTABLE EQUILIBRIUM MODEL

householdcontributes to production. thelast variable,e(st), repreFinally,

John R.Freeman andDaniel Houser

Government amounts to a mixoftaxesandreturns on debt. policy De-

= government's policyas 11_l(St). Let x(5t) =_(c(st) ?(st), b(st)) represent

dexedby the stateof thepolitical-economic the world, st.Abbreviate

the allocationfortherepresentative household forst.Abbreviate this

x =_x(st). Now thehouseholdbases itsallocationdecisionson government

I. il * solves thegovernment's problem:

where&a is thecoefficient in themore complete expression A(st) = aO + (1 + p)t c(s)

We do notattempt toparameterize butrather subsume itsvaluein al .) c(s?) here,

A COMPUTABLE EQUILIBRIUM MODEL

(st)c(st) + U(Sts)tl(st)] = UC(s1)[R(s1)b(s0) + A]

R. Freeman John andDaniel Houser

Theutility function is assumed tohavea standard form; that is,

A COMPUTABLE EQUILIBRIUM MODEL

= .99, and Zhigh= 1.01. .91, zlow

John R. Freeman and Daniel Houser

A COMPUTABLE EQUILIBRIUM MODEL

John R. Freeman and Daniel Houser

Table 2.2 OSTROM & SMITH (1981-88) t+ 1

Table 2.3 BRODY (1964-86) t+ 1

.32 .68 .38 .62

.50 .50 .36 .64

.33 .67 .45 .55

Withthe parameters described

A COMPUTABLE EQUILIBRIUM MODEL

minishing shock(row 6 of theTable), government chooses a lowertax rate

JohnR. Freeman and Daniel Houser

ON\ ~~~ =~~~~~~~~~~~~~r

andDaniel Houser John R. Freeman

BaselineParameterization with Figure1. A SingleSimulation

0.305.... ... .... ...

--------- ----- ---------~~~~~~~~~~~~~~~~~~~~0.30

A COMPUTABLE EQUILIBRIUM MODEL

Table5. The BaselineModeland theData

0.008 (0.001) 0.235 (0.003)

and Daniel Houser John R. Freeman

A COMPUTABLE EQUILIBRIUM MODEL

John R. Freeman and Daniel Houser

Figure 2. A SingleSimulation with HighApproval Shocks

1.00 0.80 0.60 0.40 . -

5w 02..................... -0 2?0? ....-0 40 .. . . . .. . . .

A COMPUTABLE EQUILIBRIUM MODEL

Table6. LargeApproval Shocksand BaselineModels

John R. Freeman and Daniel Houser

Target with HighApproval 3. A SingleSimulation Figure

....L\ -----..... ... .. -~0.16-.lo. 0.15

--.......... .............---. ........111il

A COMPUTABLE EQUILIBRIUM MODEL

Table 7. High Approval Targetand Baseline Models

ON\ ~ =~~~~~~~~~~~r