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ubject of this book is the intersection between political science and macroeconomics. The central idea is the existence of a political economic equilibrium in which the government acts to dampen the business cycle. The election cycle implies that this equilibrium may be a cycle rather than a point. An extension of new Keynesian theory provides a model of endogenous stabilization in which the government practices short-run stabilization policy which dampens the impact of exogenous shocks. This is a situation in which rational voters favor discretionary policy over a fixed policy rule even with rational economic agents. Special attention is given to the relevant data and to the poss¤ibilities of hypothesis testing.

A standard model of activist macroeconomic policy derives a monetary reaction rule by assuming that governments have performance objectives, but are constrained by an augmented Phillips curve. In addition to monetary policy governments apply a variety of instruments to influence inflation and output, including fiscal policy, bailouts and exchange rates. Solving the Phillips curve and reaction rule for a reduced form, we study this model with a panel of OECD countries. A textbook version of the activist model leads to implausible results. The econometric results are much enhanced by accounting for serial correlation among output shocks. Our results suggest that governments do lean against inflation shocks, but not output shocks, although the flatness of the Phillips curve limits policy makers' ability to effective lean against the wind. Furthermore, the activist model fits the data only slightly better than a flat-Phillips-curve benchmark. Some results are unexpected, like the estimated slope of the Phillips curves and the implied stabilization behavior of Finland, Japan and US policy makers.

Carlin and Soskice (2005) advocate a 3-equation model of stabilization policy, the IS-PC-MR model. Their third equation is the monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by an augmented Phillips curve PC. Central banks achieve their preferred outcome by setting interest rates along an IS curve. We simplify their model to 2 equations (PC and MR), developing a state space econometric specification of this solution, and adding a random walk model of unobserved potential growth. Applying this model to a panel of North Atlantic countries, we find it historically consistent with an inflation target of about 4%. Significant interdependence is found in the between-country covariance of inflation and growth shocks, but not of potential output. Beginning with the approximation that expected inflation is the most recent observation, we extend the model to introduce alternative assumptions about expectations with mixed results, support for the stickyprice model, but doubts about activist policy.

Carlin and Soskice (2005) advocate a 3-equation model of stabilization policy. One equation is a monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by a Phillips curve PC. Central banks attempt to implement these objectives by setting interest rates along an IS curve. They label this the IS-PC-MR model. Observing that governments have more tools than just the interest rate, we drop the IS equation, simplifying their model to 2 equations. Adding a random walk model of the unobserved potential growth, we develop their PC-MR model into a state space specification of the short-run political economy. This is an appropriate econometric method because it incorporates recursive forecasts of unobservable state variables based on contemporaneous information measured with real-time data. Our results are generally consistent with US economic history. One qualification is that governments are more likely to target growth rates than output gaps. Another is that policy affects outcomes after a single lag. This assumption fits the data better than an alternative double-lag timing: one lag for output, plus a second for inflation has been proposed. We also infer that inflation expectations are more likely to be backward rather than forward looking.

Carlin and Soskice (2005) advocate a 3-equation model of stabilization policy to replace the conventional IS-LM-AS model. One of their new equations is a monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by an augmented Phillips curve PC. They label their replacement model the IS-PC-MR. Central banks achieve the PC-MR solution by setting interest rates along an IS curve. Observing that governments have more tools than just the interest rate, we simplify their model to 2 equations. We develop a state space econometric specification as the solution of these equations, adding a random walk model of the unobserved potential growth. Applying this method to a panel of North Atlantic countries, we find it historically consistent with a few qualifications. For one, governments are more likely to target growth rates, than output gaps. And, inflation expectations are more likely backward looking, than rational, but a two-step estimation based on a forward-looking sticky-price model dramatically improves the empirical fit. Significant interdependence can be seen in the between-country covariance of inflation and growth shocks.

Originally presented as an empirical regularity, a variety of microeconomic derivations of the Phillips tradeoff between inflation and real output have been developed. Since these new Phillips curve models are expressed in terms of unobserved variables and expectations, we develop estimates of these unobservables using a state space characterization of the short-run political-economic equilibrium. This method is appropriate because it yields recursive forecasts based on contemporaneous information, and because we apply it to a real-time data set in order to accurately measure available information. Although none of the new Phillips curve tested are completely adequate, we find that Calvo's sticky price formulation provides the best fit for US data. It is inadequate because the estimate coefficient for the driving variable (either the output gap or the marginal cost) is essentially zero.

In the new Keynesian model of endogenous stabilization governments have objectives with respect to macroeconomic performance, but are constrained by an augmented Phillips curve. Because they react quickly to inflation shocks, governments can lean against the macroeconomic wind. We develop an econometric test of this characterization of the political-economic equilibrium using the Kalman filter. Applying this methodology to a variety of quadratic social welfare functions, we find that an inflation target functional form is consistent with US history. We also find it more likely that expectations of inflation are adaptive, rather than rational.

In the new Keynesian model of endogenous stabilization governments have objectives with respect to macroeconomic performance, but are constrained by an augmented Phillips curve. We develop an econometric characterization of the political-economic equilibrium using the Kalman filter to model the unobserved natural rate. Applying this methodology to a panel of North Atlantic countries, we find it consistent with history with a few qualifications. For one, governments are more likely to target growth rates, than output gaps. And, inflation expectations are more likely adaptive, than rational. Also, the error restrictions implied by the standard inflation-productivity shocks formulation needs to be relaxed.

We examine the explanatory power of a political—business cycle theory in which governments practice short‐run policy to lessen the impact of exogenous shocks. Governments have ideological objectives with respect to macroeconomic performance, but are constrained by an augmented Phillips curve. The most prominent version, the rational partisan model, incorporates forward‐looking expectations. This model can be compared to a competing model based on backward‐looking expectations. Alesina and Roubini's recent advocacy of the rational model uses OECD data. Our reconsideration of the same data, updated to 1995, suggests that the adaptive expectations version offers a better explanation than the rational one.

The life cycle of a dwelling unit is a succession of tenants, generally proceeding to lower-income groups, and a sequence of quality levels, generally ending in a dilapidated state. The process of tenant turnover mirrors a neighbourhood turnover process which is identified as contributing to antagonism between social classes. The paper develops an optimal control model of the housing life cycle and extends this model to incorporate housing codes and rent control. The efficacy of these two popular policy instruments is investigated with respect to the goal of encouraging housing stability and thus neighbourhood stability.