Public Choice 73: 21-35, 1992. © 1992 Kluwer Academic Publishers. Printed in the Netherlands. Testing the satisficing version of the political business cycle 1905-1984" LAWRENCE S. DAVIDSON MICHELE FRATIANNI JISRGEN VON HAGEN Department of Business Economics and Public Policy, Graduate School of Business, Indiana University, Bloomington, IN 47405 Received June 1990; accepted August 1990 Abstract. This paper develops a test of the satisficing version of the political business cycle. Previ- ous tests have focused on maximizing models of political behavior and are not sufficiently general to test for satisficing behavior. Using annual U.S. data for the period 1905 to 1984, we find evi- dence supporting the satisficing version of the political business cycle model, but we reject the max- imizing version. In accordance with the satisficing hypothesis, we find that increasing inflation or unemployment and decreasing monetary base growth in the third year of a presidential term are followed typically by reversals during the election year. 1. Introduction Does knowing the date of the next Presidential election improve the forecast of economic variables? According to Nordhaus (1975) and MacRae (1977) the answer is 'yes' because incumbent politicians have a singular interest in gaining reelection. These politicians have no misgiving in manipulating the economy so as to create better economic outcomes in the sense of currently observed phenomena before elections. Assuming a myopic public and an economic structure described by a stable Phillips Curve, the incumbent is able to max- imize reelection chances by choosing the vote-maximizing combination of inflation and unemployment. 1 This is the essence of the political business cycle (PBC). PBCs imply that knowledge about the dating of the next election can improve forecasts of economic variables such as inflation, unemployment and output. This political behavior also implies cycles in policy variables such as the monetary base. Recently, Rogoff and Sibert (1988) and Laechler (1984), among others, have shown that political business cycles can arise even if voters are not myopic and form expectations rationally. * We wish to thank Gordon Tullock and two anonymous referees for valuable comments.