Gross Domestic Product and the Post-Keynesian Paradigm (Coursework Sample)

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Economics Perspective
Introduction
Economy experiences macroeconomic fluctuations over time that affects economic growth. The aggregate output, consumption, investment, net export, and employment may tend to grow over time but then drop suddenly. Economists continue to discern the current condition of the economy and where it is heading so that they can effectively deal with future economic events. Macroeconomic fluctuations mainly involve changes that occur in the demand-side of the economy, which determine the gross domestic product.
GDP= C+I+G+NX
Gross domestic product is never constant, but change due to many reasons like changes in government policies mainly in interest rates and taxes. Different economics theories have evolved with time to explain macroeconomic fluctuations.
* Political Business Cycle (Rational partisan political business cycle models)
Political economists continue to study and research how politician pressures and interest groups within a country can lead to macroeconomic fluctuations. Political business cycle explains business cycles resulting from the manipulation of policy tools (monetary and fiscal policy) by incumbent governments so that they can get re-elected and stay in office (Paldam 342). These governments hope to stimulate the economy just before general elections for them to improve their parties’ re-election chances. The cycle explains the interaction between macroeconomic and political variables in the election of new governments through focusing on the dynamics between the incumbent and the electorate. According to this cycle, the voters maximize their individual utilities, while the incumbent is expected to implement the policies that allowed it to retain power. Expansionary fiscal and monetary policies have many favorable consequences in the short run such as the creation of jobs, fall in interest rates, tax cuts, and increase in government spending to stimulate economic growth. However, the same fiscal and monetary policies have other very unpleasant consequences such as damage to foreign trade balance and accelerating inflation. Others include low rates of savings to support investments and long-term expansion of the government share of the gross domestic product at the citizens’ disposable income. After elections, politicians may manipulate powers by raising taxes, allowing interest rates to rise, slowing the growth of the money supply, and by cutting spending. These actions continue until just before the next election. Therefore, holding of elections at regular intervals facilitates macroeconomics fluctuations (a boom and bust pattern).
Rational Partisan Business Model
The model of rational partisan predicts that macroeconomic fluctuations are triggered by any possible change in government policies as a result of elections. In this model, agents face uncertainty regarding the outcome and timing of the next election. It further predicts that the partisan influence on the state of the economy persists throughout the current government’s rule. The state of the economy is further influenced by the party that ruled before the current one. Moreover, the popularity of the party also has a significant influence on the macroeconomic fluctuation.
The rational partisan model involves a two-party political system whereby each of these two parties has its policy platform (Alesina 58). While the left-wing party fights for growth and unemployment, the right-wing party is more concerned with fighting inflation. The left-wing governments’ core constitutions are composed of blue-collar workers and are more vulnerable to unemployment during economic downturns. The right-wing party is made up of white-collar professionals whereby their employment prospects have been much more stable over time. This group is concerned with retaining the real value of its asset through low inflation. The key parties are the electorate, but not political candidates, where each voter elects the candidate he/she thinks better suits his/her preferences according to party platforms.
In this model, the policy is uncertain in the presence of election, because the election winner (and the future controller of policy), is not known with certainty. This uncertainty leads to short-term business cycle effects (macroeconomic fluctuations) as the agents then form inflammatory expectations (as a weighted average) of the parties’ expected policies. In the end, each election held leads to new and different inflation rate from the expected one. If the left-wing party wins, there is a high expectation that inflation will rise, and the economy is to grow more rapidly than normal. However, if the right-wing side is victorious, there is an economic downturn due to unemployment, low government spending, and low inflation. In short, the rational partisan model predicts that regular elections usually lead to temporally macroeconomic fluctuations due to the existence of uncertainty over elections outcomes. Additionally, the winning party determines the direction of the fluctuation.
A rational partisan business model explanation framework
As above, rational partisan business model differs from traditional partisan in that a voter forms inflation expectation rationally and that the elections’ outcomes are uncertain. Additionally, politicians in the partisan business model have different preferences. The right-wing party focuses on economic growth and unemployment and the left-wing party fights inflation.
Let us consider two political parties N and M. Party N is more concerned about fighting inflation that focusing on growth and unemployment, and party M is more concerned with economic growth and unemployment than inflation.
UN = - (YT – XN )2 + BNJT ; XN > 0, BN > 0
UM = - (YT – XM )2 + BMJT ; XM > 0, BM > 0
In the formulas, the subscripts N and M denote the two parties (Alesina n. p). In the formulas, XN and XM represent the targets rate of inflation of the parties N and M respectively in their policy platform. Additionally, since the economic rate states that the optimal level of inflation is never zero, the target rate of inflation of the two parties is positive. BN and BM represent the benefits of these two parties. The relative references of these parties (inflation, unemployment and growth) are represented by XM > XN > 0 and BM > BN > 0.
To interpret the first formulae, party N is more concerned about output and unemployment than party M is. Party M is more willing to utilize inflation into promoting growth and fighting unemployment than partly N is. However, the above representation does not mean that N is not concerned about inflation, or M is not concerned about economic output and unemployment. It is only that each political party has preferences that it is relatively concerned more the others.
Since voters have different preferences based on unemployment and inflation, they tend to elect the candidate that they think would deliver the highest expected utility. It is the reason voters who prefer low inflation levels would vote party M, and those who are more concerned with unemployment would vote for party N.
The model stresses that apart from the winning party, the level of inflation and hence economic growth will much depend on the degree of political polarization. Polarization refers to how different are policy platforms. This argument is backed by Lunati, Alesina, and Rosenthal, who stress that political polarization creates wider economic fluctuation (176).
As a summary of the above presentation, if the party N wins, inflation would increase above expectations and also the output would grow above its natural level. On the other side, if M wins, inflation would be below the expected levels, and the output or economic growth would be below its natural rate. The total output will be expected to return to its natural level in the second period (next election) regardless of the party that will win. This observation is due to the inflation expectation (wages) adjustment in the economy. The cycle between the output, employment and inflation will continue causing macroeconomic fluctuation if the election will continue to be held.
Real world example of rational Partisan Models
Research prove that over the years, the United States gross domestic product (GDP) growth is substantially lower under Republicans than Democrats in the second and theirs year of their administrations. Between 1949 and 1994, the growth rates during Republican and Democrats’ administrations sharply diverge starting from the third quarter after the election. Moreover, the quarterly rate of growth averaged over Democrats administration increases from 3% per annum in the third quarter to 6% by the seventh quarter in the administration’s term of office. However, it falls from the same level to zero by the seventh quarter in the term of administration averaged over the Republican administration. After some time, the economic performance under the two parties becomes identical (Drazen 8).
* The post-Keynesian Paradigm
The post-Keynesian paradigm is a collection of emerging schools of economic thoughts that attempt to reflect the basics and the work of John Maynard Keynes. Although these schools are much related to the work done by Keynes, they have introduced new insights and ideas not found in Keynes book, and that can help explain macroeconomic fluctuations. It is the study of the economy carried out after 1936 (Trezzini 10).
Effective demand and macroeconomic fluctuations
The principle of effective demand is the post-Keynesian paradigm primary focus. This theory defines effective demand as the actual quantity of products that buyers are purcha...