HEDGE: A method of protecting against financial (or other types) of loss by counterbalancing an action. This is commonly seen in the financial markets when investors buy options or futures contracts to protect themselves against price changes. A hedge is essentially a form of insurance. An investor hopes the price of a financial asset doesn't fall, but buying a futures or options contract can reduce the loss if this occurs.
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POLITICAL BUSINESS CYCLES:
The notion that business cycles are caused by elected government leaders who manipulate the economy to achieve personal political goals, that is, to be re-elected and remain in office. The leaders stimulate the economy leading up to an election, creating a business-cycle expansion that ensures (they hope) re-election, they then induce a business-cycle contraction after the election to correct problems created by the pre-election stimulation. This explanation suggests that government is the source of business cycles are should not be allowed to implement discretionary stabilization policies. Politically-motivated government intervention in the economy is one of dozens of potential causes of business-cycle instability and the onset of business-cycle contractions.
An important implication of political business cycles is that government (especially the elected politicians who run government) is the primary cause of business-cycle instability. This further implies that the way to correct business-cycle instability, and the problems of unemployment and inflation, is to limit or prevent government leaders from discretionary control over fiscal and monetary policies.
Four PropositionsThis explanation of business-cycle instability is based on four propositions:
- Politicians seek re-election. Elected leaders remain elected leaders only if re-elected. Perhaps more than a few elected leaders are ONLY interested in remaining in elected office and all that this entails for their personal well-being. Even those elected leaders who are primarily interested in promoting the public good, with no regard for their personal well-being, can only do so if they are re-elected.
- A significant number of politicians periodically seek re-election. Every four years the President, one-third of the Senate, the entire House of Representatives, and numerous Governors, state legislators, Mayors, city councilors, and others are up for election. This tends to create a common mind-set that often cuts across political ideologies.
- Voters tend to vote their pocketbooks. The voting public generally re-elects current leaders during business-cycle expansions and new ones during business-cycle contractions. Voters tend to be more interested in their how the economy affects their personal situations (jobs, incomes, and living standards) than distant national or international issues (wars or political scandals). Whether or not justified, they also tend to give current leaders the credit for the good times and the blame for the bad times.
- Government intervention can affect the economy. Stabilization policies under the discretionary control of elected leaders can be used to affect business-cycle activity. Government leaders can stimulate the economy by reducing taxes, increasing expenditures, and expanding the amount of money in circulation. They can also constrict the economy with opposite changes in these three policy tools.
The Political Cycle In ActionWhen these four propositions are combined, they paint a picture of politically-induced business cycles. The story goes something like this:
- First, elected leaders, seeking an election on the horizon, decide to promote a business-cycle expansion. Of course, expanding the economy does not happen overnight. It takes about 2 to 3 years before government actions affect the pocketbooks and living standards of the voters.
- Second, leaders stimulate the economy, primarily through fiscal policy changes in government spending and taxes. Lower taxes and more spending are the perfect means of inducing an expansion, making voters happy, and ensuring that elected leaders are re-elected. Not only do these actions stimulate the economy, but voters are usually pleased to pay fewer taxes, and get more government goodies. A cooperative Federal Reserve System, which controls the money supply, might also enable a little stimulatory monetary policy. Getting extra money into circulation is also bound to please the voting public.
- Third, if all goes well, a business-cycle expansion is in full force come election time. The voters are happy, the leaders are re-elected, and all is good with the world. Well... not quite. Lower taxes and increased government spending are bound to create or worsen budget deficits, especially the federal deficit. The extra money added to the economy is bound to cause inflation.
- Fourth, the re-elected leaders recognize that the steps taken to promote prosperity cannot be maintained (especially through the next election). As soon as the last vote has been cast, the re-elected leaders undertake stabilization policy steps to correct or prevent the ills resulting from the pre-election stimulation. They increase taxes, decrease government spending, and reduce the amount of money in circulation.
- Fifth, this post-election stabilization policy reversal is bound to cause a contraction and make voters unhappy. Fortunately, for politicians anyway, the contraction hits after the election and only lasts about a year. The leaders have plenty of time to work their expansionary, happy voter, policy magic before the next election.
What It MeansThis explanation of business cycles paints a picture of an economy expanding 2 to 3 years before election, then contracting for a year or so after. The end result is relatively regular, if not predictable, 4-year business cycles.
While the data are not entirely consistent with a 4-year political business cycle, they do offer support. Election outcomes, especially for the Presidency, do largely depend on the state of the economy. Elected leaders do act on this information and attempt to stimulate the economy leading up to an election. Evidence also shows that a number of official contractions and unofficial economic "pauses" have occurred shortly after major Presidential elections.
However, the results are mixed. While politicians might do their level best to generate a political business cycle, they are not always successful. Other business-cycle influences, such as investment, consumer confidence, or global events, occasionally defeat the efforts of the politicians.
This political business cycle explanation is well received by folks with particular political beliefs and/or vested interests. By implying that instability is caused by government intervention in the economy, stability is achieved by preventing government intervention. This further implies that the best government policy is a "do nothing" policy. In fact, an even better option is to legally restrict government intervention through a balanced-budget constraint that prevents discretionary changes in spending or taxes or a rule mandating a constant growth of the money supply that prevents discretionary changes in the money supply.
For those with an anti-government outlook on life, with the belief that government is the PROBLEM, not the SOLUTION, this explanation is well-received. In addition, for those with a vested interest in government actions, that is, those who would rather not have government intervening in the lives, then this explanation is also well received.
POLITICAL BUSINESS CYCLES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 3, 2024].
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