Since WWII, the economy does better when there is a Democrat in the White House. That conclusion holds for “almost every metric” of the economy’s performance according to research by Princeton economists Alan Blinder and Mark Watson. But is this due to policy differences between Democratic and Republican administrations? Or, with the limited number of observations since WWII, is this simply a statistical artifact, simply the luck of having Democrats in the office when good things happen?
The dominant position among economists, one I’ll push back against, is that presidents have little ability to influence the economy. Steven Dubner, one of the authors of Freakonomics, gives the standard response:
“…just once I'd love a presidential candidate to get up there on the stump and say: 'My fellow Americans, I can't control the U.S. economy. I've got a little bit of influence but mostly it does what it does. So if it gets worse on my watch, you shouldn't blame me -- and if it happens to get better, you probably shouldn't give me too much credit either.'”
Austan Goolsbee, quoted in the same interview, echoes this:
“I think the world vests too much power -- certainly in the president, probably in Washington in general -- for its influence on the economy, because most all of the economy has nothing to do with the government.”
I disagree. Whether the president is a Republican or Democrat can make a critical difference for the economy.
Let’s begin with monetary policy. Yes, it’s true that monetary policy is largely independent of government. But which policies are chosen depends upon who is in control of the Fed. Although the Federal Reserve system was set up so that no president could appoint more than two of the seven Federal Reserve Governors in a four year term, four of the seven in an eight-year term, this is not how the system has worked in recent years.
Due to the large number of resignations before Federal Reserve Governors have served their full fourteen-year term, both Obama and Bush have appointed all of the members of the Federal Reserve Board. This is important because so long as the seven Board members are united on policy matters, they can dominate the vote on the twelve-member monetary policy committee. Thus, the president has a large influence on the shape of monetary policy. If, for example, John Taylor was currently the chair of the Fed, and if a Republican had appointed the supporting cast, does anyone doubt that policy would have been much different? Would interest rates still be at the lower bound? Would the Fed’s balance sheet be as large?
Fiscal policy brings up similar concerns. If a deep recession occurs, both Republican and Democratic administrations are likely to turn to fiscal policy when monetary policy alone is not enough to turn around the economy. But the extent and composition of the policy – tax cuts versus government spending – as well as whom the policy is directed at – the wealthy versus the middle class – make a difference for how well the policy works.
For example, there’s little evidence that cutting taxes on the wealthy spurs economic growth, particularly in a severe recession when the tax reductions mostly end up as idle savings (tax cuts for the working class have a larger impact). But there is considerable evidence that government spending has a significant multiplier effect in deep recessions. The current recession is a good example.
Democrats would support a large investment in infrastructure, or government spending more generally, to spur the economy but can’t get Republicans aboard, and Republicans would salivate at a large tax cuts, but Democrats won’t go along. This also highlights that it is not just the president alone that matters, the interaction between which party controls congress and which party holds the presidency can also have a large impact on our ability to do fiscal policy at all.
Confidence can also matter. According to the Blinder and Watson results, one of the reasons the economy does better under Democratic administrations is that “consumers, expecting faster growth under Democratic presidents, buy more durable goods on that belief, which makes the economy grow faster.” But this goes beyond consumer confidence. When businesses are more confident that the government will intervene actively to stabilize economic fluctuations through monetary and fiscal policy, they will be more willing to make long-term investments, an important component of economic growth.
Finally, although this is unlikely to have a major impact, international relations, support of trade deals, the willingness of foreigners to invest in businesses within the US, and so on can also affect the economy. The real danger here is that the president will do something dumb that causes turmoil in the Middle East and drives oil prices much, much higher (see Republican statements on the campaign trail), or takes some other action that causes a large disruption in international relationships.
We don’t know when the next severe economic downturn will occur. Some type of disruptive economic event, while far from inevitable, could certainly occur within the next decade. Who knows what the composition of the Fed will be when that happens, and how it will react. Will the Fed take a hands-off approach to the next financial downturn or will the Fed be highly interventionist? Will it be willing to do QE once again? If the Fed runs out of ammo, as it did during the Great Recession, will fiscal policy come to the rescue? If so, will it be mostly tax cuts or government spending increases?
Whether the president is a Republican or a Democrat could make a critical difference in how well we respond to the next economic crisis. My own preference – a strong one – is to have a president willing to use fiscal policy if it is needed and willing to appoint Federal Reserve Governors who will also take creative and forceful action in response to disruptive economic forces. Your preference may differ (and thus fly in the face of the evidence) – but make no mistake about it. Your choice at the ballot box could make a big difference to you and your family.