TCS Daily

The Sigh-Of-Relief Binge

By Kevin Hassett - December 24, 2003 12:00 AM

One of the striking regularities in the economic data is the recurrent propensity of incumbents to do very well in elections when the economy is doing well. As Yale economist Ray Fair and a number of others have found, there is a strong and statistically significant relationship between economic data and electoral outcomes. The evidence suggests that voters give Presidents in particular a great deal of credit or blame for the state of the economy.


If that pattern continues, President Bush will be a very happy man next year. This week's final GDP report for the third quarter indicated that GDP growth was indeed as fast as preliminary estimates suggested, with blockbuster growth in consumer and business spending driving growth above 8 percent. A number of details below the top line suggest that the economy's momentum will sustain itself in the fourth quarter and into next year. Business capital spending jumped 12.8 percent, and recent orders data suggest that the surge in capital spending is the front of an enormous wave of capital purchases rather than a temporary blip. In addition, consumer spending on big-ticket items, especially automobiles, suggested that heady times are here again.


Now that the evidence is so clear that the economy has recovered, economists have begun to attempt to allocate the credit for the turnaround amongst the various candidates. Several of my economist friends and I debated the proper allocation over lunch a few days ago, and the most surprising outcome of our chat was our unanimity. Both the Democratic and Republican economists present agreed that the biggest single contributor to the explosion of growth has been the strange sequence of exogenous shocks that kept the economy on hold for almost two years. The oil shock of the election year was followed by the terrorist attacks on 9/11, which lead to war in Afghanistan and then war in Iraq. Each time the economy seemed poised to soar, another geopolitical shock occurred that signaled to economic agents that they should hold off making big decisions until the dust settled. Now that Saddam is out of power, we have experienced a lengthy period without any new shock, or even rumor of a new shock, and the result has been astonishing growth.


Why is the growth so astonishing? Think of it this way. If you were nervous that you might lose your job, then you might hold off from purchasing a new car. After a year or two of repairing your old car, suppose that you received a great evaluation from your boss. That evaluation might make you feel more secure and likely to buy a car, but there is another thing contributing to that as well. Because of your prior caution, you are driving around in an especially old car! Accordingly, if collectively firms and consumers wake up from a long nightmare and decide that the sun is shining again, then they will look at their capital and durable goods and think "I need to replace that old piece of junk" and their spending will surge enormously.


This pattern is unusually striking today because of the repeated shocks. Indeed, the sigh-of-relief binge is only just beginning. Next year will likely be one of the better years on record for capital spending and GDP growth.


Tax policy has certainly helped get the binge going -- my friends and I seemed to agree that GDP growth has been about a percent higher over the past two years because of tax policy. Aggressive monetary policy has also greased the wheels. But the absence of geopolitical disruption (and the presence of so much disruption in prior years) explains our current good fortune. Good policy can help around the edges, but 8.2 percent GDP growth cannot possibly be attributed to it.


The election melodrama that will unfold next year will obscure these points. President Bush and his supporters will claim that the booming economy proves that he is a policy impresario; the Democratic challengers will claim that the growth will surely reverse itself soon because of Bush's terrible policies. Both will be wrong, but political history suggests that voters will be listening.

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