Public Perceptions of Macroeconomic Policy: An Econometric Analysis of the Reagan Presidency Author(s): David J.

Smyth and Pami Dua Source: The Review of Economics and Statistics, Vol. 70, No. 2 (May, 1988), pp. 357-361 Published by: The MIT Press Stable URL: http://www.jstor.org/stable/1928324 . Accessed: 24/10/2011 05:14
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"The Real Costs of Tuition Tax Credits," Public U. S. Department of Commerce,CountyBusiness Patterns _____ Choice 46 (1) (1985), 61-70. Office, 1971, Printing D. (Washington, C.: Government SchoolsProduceHigherLevels Willms,Douglas J.,"Do Private 1981). New Evidenceforthe Tui-ofAcademic Achievement? West, E. G., "The Education Tax Credit Proposal," Cato tion Tax CreditDebate," in Thomas Jamesand Henry PolicyReport3 (Sept 1981). Institute M. Levin (eds.), PublicDollarsfor PrivateSchools: The "Are American Schools Working?DisturbingCost ____, (Philadelphia:TempleUniCase of TuitionTax Credits PolicyAnalysis26 and Quality Trends,"Cato Institute Press,1983), 223-231. versity (August 9, 1983).

PUBLIC PERCEPTIONS OF MACROECONOMIC POLICY: AN ECONOMETRIC ANALYSIS OF THE REAGAN PRESIDENCY David J.Smyth and Pami Dua*
Abstract-This paperestimates public's the indifference map cationof theeconometric methmodels estimation and inflation unemployment econometric and between byan analy- ods. In section of thepresent I paperwe detailsome sis of an indexof thepublic's rating President of Reagan's our -II work. Section outlines withprevious A macroeconomic policy. Box-Cox transformation is applied problems the III to monthly data. The indifference obtained markedly modeland data. Section presents econo;iietric map is of nonlinear thatthepublic's so trade-off between inflation and results IV and section thepolicyimplications the with relative ofinflation results. state unemployment greatly the varies rates V. in ourconclusions section We and unemployment. A particular change inflation unemin or ployment changesthe President's muchmorewhen rating Studies Econometric I. Previous inflation unemployment high and are than when they low. are If theunemployment is closeto itsnatural rate level, there is little incentive a President force for to down inflation a rate to previous differences, inter-study are Whilethere some closetozero. belinear regressions fitted have typically researchers A number of studies have undertaken econometric of inflation unemployment. studies deare These and betweenpresidential analysis of the relationship popu- ficient thefollowing ways. in larityand economicvariables, particularly inflation and that popularity is of the 1. First, measure presidential unemployment-Mueller (1970), Hibbs (1974), Stimson used is based on answers theGalluppoll question to (1978), "Do you approve or disapproveof the way Mr. ... is (1976), Kenski (1977a,b,c),Frey and Schneider Kernell (1978), Monroe (1978), Shapiro and Conforto handling job as President?" economists interFor the (1980a, b), Golden and Poterba (1980), Kenski (1980), estedin studying public's to comthe reaction different Hibbs and Vasilatos (1981), Monroe (1981), Chappell binations inflation unemployment is a rather and this of (1983), Monroe and Levi (1983), Norpothand Yantek unsatisfactory depends Presidential popularity measure. (1983), Monroe (1984), Chappell and Keech (1985a,b), on noneconomic onesand as factors wellas economic Ostrom and Simon (1985), and Michaels (1986). The noneconomic Attempts may influences be dominant. estimatesfromthese studiesimplyindifference curves have been made to takenoneconomic into influences for the public between inflationand unemployment. account thead hocintroductionother of to variables by to indifference curvesthe allowfora specific Viewed as attempts estimate with associated levelof popularity withrespectto each president, erosion a president's studiespossess a numberof deficiencies of the popularity the measurement presidential of the popularity, specifi- during term office, influence international of of the his
January 1987. Revisionaccepted 16, Received forpublication forpublicationOctober 14, 1987. * Louisiana State University of and University Connecticut, respectively. Stamford, of University ResearchCenter, to We are grateful the Survey of Michigan for makingavailable the resultsof theirSurveys for referees helpful and to twoanonymous ConsumerAttitudes fromcommentson an suggestions.We have also benefited earlier version of this paper when it was presentedat the Mid-West Economic AssociationMarch 1987 meetingat St. Louis and to the MacroeconomicsWorkshop at Louisiana was supported the LSU by Smyth'sresearch State University. for Foundation. We retainresponsibility any errors. ? Copyright 1988

popularity therates and of tween measure presidential a

such as the circumstances, events and particular variables as However, theadditional affair. Watergate influences, considerall do notremove thenoneconomic in relationships. able noisestillremains thefitted is incluof studies their 2. A seconddeficiency prior a Consider term sionof thecomplete ofeachpresident. or with highrateof inflation a office taking president from he or unemployment boththat has inherited his measures for time economic policy It predecessor. takes of and to haveeffect at leastsomemembers thepublic the part this. During first ofhispresidency, willrealize be cannot blamedfortheecoan incoming president

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nomic conditionsforwhichhis predecessor responsi- the public's rating of the government's is performance ble. If he is seen to be takingmeasuresto deal with withrespectto inflation unemployment. index, and The economic problems,his ratingsare likelyto be high R in montht, is givenby during a "honeymoon" period even thougheconomic (1) Rt = 100(Gt + 0.5Ft)/(Gt + Ft + Pt) variablesmay be unfavorable. Inclusionof data forthe of initial part of a presidency a formof specification where G is the proportion householdsresponding is "fair" and P is responding error and so is likely to result in biased parameter "good," F is thepercentage responding "poor."4 estimates,reduction in goodness of fit,and serially percentage The use of Rt as themeasureof thepublic's satisfaccorrelated residuals.' with the president'seconomic 3. As thepublic maynot adjustits assessment the tion or dissatisfaction of of deficiency the previous president'spolicies immediately changesin inflation policies overcomesthe first to and unemployment rates,a dynamic adjustment process studies noted above in thatit is a ratingof the president's performance withrespectto inflation specifically is likelyto be appropriate.2 4. The regressionsfitted have been linear between and unemployment. We fitour model to monthly data fortheperiodfrom presidentialpopularityand the rates of inflation and 1986. By excluding first the unemployment. This is unsatisfactory two reasons. February1982 to November for we problem The first relatesto theshape of thepublic'sindifference year of theReagan presidency are resolving Duringhis first year curves reflecting relativeextentof its aversionto 2 discussedin theprevioussection. the inflationand unemployment. Conventional utility the- in officePresidentReagan receivedquite high ratings ory suggeststhat theseindifference curveswill be non- forhis economicpolicies even thoughtherate of inflafromPresident Carterremained linear, the trade-off, marginalrate of substitution, tion that he inherited or rate As betweeninflation and unemployment with the highand the unemployment was rising. predictvarying twelvemonthsof the relative rates of unemployment and inflation. Linear ed, when we included the first regression rules out such a possibility because it impos- Reagan presidency in our calculations, there were values and reduction in es straight-line indifference curves.Theoretical analyses marked changes in parameter was introinvariablydraw the indifference curves as concave to the goodness of fit and serial correlation duced. the originratherthanas straight lines. During the 58 monthperiod fromFebruary1982 to 5. The use of linear regressions also imposes the constraint that the public's indifference curves are November 1986 the index Rt, averaged 51.85 with a equidistantat all ratesof unemployment inflation. standarddeviation5.87. The rangeof R was from low and For instance,a reduction theinflation in ratefrom 10% of 37.11 in February1983 to a highof 59.09 in January to 9% would cause the same absoluteimprovement a 1985. in The model we fitis president'spopularityas a reductionin the inflation rate from3% to 2%. This is an unwarranted restraint to Rt(X) = ao + alitAN + a2Ut(X) + a3R2)1 + et (2) impose a priori on the form of the public's utility whereforany variable function. X(X) (3) Xx - 1)/A II. The Model and Data and In its monthlysurveyof approximately house700 holds (a country-wide randomsample) the SurveyResearch Center of the University Michigan asks the of question"As to theeconomicpolicyof thegovernment -I mean steps taken to fight inflation unemployor ment-would you say the government doing a good is job, only fair,or a poor job?"3 From the answersto that question we have constructed monthly a index of R = indexof thepublic'srating President of Reagan's performance; = therate of inflation overthepast twelve months calculated fromthe consumerprice index, all urban consumers, items,seasonallyadjusted, all expressedas a percentage; U= the unemployment rate for all civilianworkers 16 yearsand over,seasonallyadjusted, expressed as a percentage; e = the disturbanceterm,normallyand indepenwithzero mean and constant dentlydistributed

1 Chappell (1983), Monroe (1984), and Chappell and Keech (1985a, b) attempt takeaccountof a "honeymoon"effect to by the use of dummyvariables. 2 Kernell(1978) includes laggeddependent a variable.Monroe 4 We repeated our analysis using the percentage house(1978,1981) uses an Almon distributed lag. Hibbs (1981), of Chappell (1983), and Chappell and Keech (1985a,b) use a holds responding + "good," thatis 1OOG,/(G, F, + P,) and the weighted average of currentand past economic variables. percentageof householdsresponding "good" or "fair,"thatis Norpoth and Yantek (1983) use ARIMA techniques. 100(G, + F,)/(G, + F, + P,). Such measures did not change 3For further information thesurvey Curtin(1982). on see our conclusions.

NOTES

359

TABLE 1. -Box-Cox TRANSFORMATION ESTIMATES, the Both P and U are laggedone monthto represent FEBRUARY 1982 TO JUNE 1985, X = 3.14 rates and inflation unemployment knownto most recent households. t-statistic Coefficient Variable data and as householdscannot be We use monthly 3.01 40.602 of ratings policyeffective- Constant x 10-3 expectedto fullyadjust their -2.58 -84.154 ness withinsuch a shortperiod,we assume a dynamic -1.96 -37.053 processand includeR, 1 as an explanatory Ut(AX adjustment 6.06 0.656 R(tA-)1 variable. The use of a dynamic adjustmentprocess Adjusted R2 0.817 overcomesour thirdobjectionto previouseconometric Durbin's h 0.471 work. on As we do not wish to imposethe rigidrestrictions we function, have written of theform thepublic'sutility in equations (2) and (3) the Box-Cox transformation in the errortermas indicatedby the Durbin's h-statiswhich has as a special case the linear model, when tic. In response to a changein U,_1or Pi,- the index level. to Rt adjusts monotonically a new equilibrium model,when X = 0. X = 1, and the loglinear betweenR'114 and the of The proportion the deviation allows us to Use of the Box-Cox transformation is In estimatenonlinearrelationships. thepresentcontext equilibriumlevel of R3 4 eliminatedin any month given by 1 - a3 = 0.344; 72% of the adjustmentof First,we avoid there are two types of nonlinearities. level is made in threemonths lines R3.14 to its equilibrium curvesto be straight the constraining indifference and 92% is made in six months. shaped indifferand can thus estimateconventionally curvesimplied indifference To obtain the equilibrium ence curves. Secondly,we can allow for a particular by our estimateswe writeRt = Rt-, and then solve effects quantitative change in P or U to have different to coefficients equations (2) and (3) withthe estimated levelsof P and U, thatis, foraR/aP on R at different withany of of and aR/IU to be a function P and U. We are thus yield the combinations P and U consistent value of R. We have errors present particular able to avoid the potentialspecification and objectionsto the in earlierstudies-our fourth fifth previousworknoted above. P = (1516.408 - 0.00409R3.14 _ 0.440U3.14)0-318 (4) Estimates III. Empirical curves,the value 1 In figure we plot some indifference

of estimate X is 3.140. The The maximum-likelihood coefficient estimates obtained with this value of X, and withthe t-statistics otherrelatedstatistics, together are givenin table 1. regionfor X The lowerbound of the 95% confidence that we is 1.68. Accordingly, rejectboth thehypothesis that and X = 1, the linear specification, the hypothesis X = 0, thelinearin logarithms specification.5 at are All the coefficients significant the 95% conlevel.6 There is no problemof serialcorrelation fidence

its by of R forany curvediffers 4 unitsfrom neighbor. IV. of PolicyImplications theResults

map, satisfaction For any point on the indifference increaseswith a with PresidentReagan's performance towardsthe origin.The indifmovement southwesterly Whilethe the curvesare concavetowards origin. ference 1 in curvesthatwe have represented figure indifference have been drawn foran extendedrangeof values of P of for and U, policyconclusions combinations P and U that are far distantfromthe observedvalues of P and is for specification s The result thelinear U should be made withsome care. As predicted by economic theory,the indifference Rt= 21.194- 0.547P,1 - 0.581U,_1 is The concavity curvesare concave towardstheorigin. (-1.31) (2.45) (-2.24) curve the marginal quite marked.On any indifference +0.726Rt_1. and betweenthe rate of inflation rate of substitution (7.15) that keeps R constantvaries markedly unemployment at of The coefficient U is notsignificantthe95% confidence dependingon the relative of magnitudes P and U. We indifference the this map level.In equilibrium, yields linear by may calculate the marginal rate of substitution P = 38.753- 1.062U- 0.501R. calculating dP/d U. It is
6 As we have predictions we forthe signsof the coefficients use a one-tailedtest.We also repeatedour analysiswith the dividedby populationof workrate (employment employment rate did The ing age) replacingunemployment. employment of rate,the t-statistic not work as well as the unemployment rate of the coefficient the employment beingonly0.82.

daP/d = -0.440(U/P) U

(5)

of combinations P and U yield markedly Differing As marginalratesof substitution. U/P varies different

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FIGURE 1.-PUBLIC'S
10 I,

INDIFFERENCEMAP: REAGANPRESIDENCY
I I I I I I I,

R =3482 R =462-

.,

-,

6~

~
-5

8
0
u-

9 10 11 12 UNEMPLOYMENT

from1 to 2 to 3 to 4, aP/lU - 1.94 to - 4.62 to - 8.55.7 We also have aR/aP = - 244.634( P/R)214

varies from -0.44 to

TABLE 2.- INFLATION RATES AND RATING INDEX IF THE NATURAL RATE OF UNEMPLOYMENT is 7%

P 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

R 36.42 44.97 49.72 52.62 54.57 55.72 56.38 56.69 56.80 56.81

ARI@ U = -107.712 ( U/R)214

(6)

Inspection of these resultsor figure makes it clear 1, on thattheeffect R of a particular changein therateof if inflation in the unemployment is greater the or rate values of P and U are such thatR is low, thanif it is high.8 of Finally,we considertheimpiications theshape and rate positionof our indifference curvesforthelong-run of inflation. Consider a president concernedabout the In public's ratingsof his performance. thelong run the rate lowest unemployment thatcan be sustainedis the naturalrate of unemployment. is We believe the naturalrate of unemployment currentlyabout 7%. In table 2 we give the values of R to values of P forU = 7.0. The corresponding different below appresidentneeds to get the rate of inflation 7% proximately to obtain a favorablerating(R < 50). increasesabove this level, the As the rate of inflation the president'sratingsdecline sharply. cutting rate By of inflation below 5% thepresident gethis ratings to can

do further in inflation cuts up to about 55 but thereafter verymuch.A zero rate of inflation not improveratings would only yield a ratingof 57. Thus thereis little down close to to for incentive a president pushinflation zero.9 V. Conclusions to responses derive In thispaper we have used survey map between inflationand the public's indifference the As unemployment. predictedby economic theory,
9 This conclusion followsalso if the naturalrate of unem-

5, in then,using the estimates footnote ence curvesare fitted is the estimatedmarginalrate of substitution a constant= - 1.062. Thus the methodsof earlierresearchers would have been quite misleadingfora wide set of values of U/P. 8 In contrastwith the linear model dR/dP = - 1.966 and is aR/dU = 2.120 and so thiseffect not revealed.

7 If the indifference is or and map is misspecified linearindiffer- ployment somewhathigher lowerthan7% because of the

steepnessof the indifference curvesat low rates of inflation. The finding consistent is withthatof Smythand Dua (1986) who combined an econometric analysisof survey data on the relative seriousnessof inflation and unemployment with the median votertheorem obtainan estimate theequilibrium to of rate of inflation approximately of 5.5%.

NOTES
indifference curves are nonlinearand concave to its origin. The rate at which the public will trade off more unemployment againstless inflation viceversavaries and greatlydependingon the absoluteand relativerates of unemployment inflation. and When both inflationand unemployment high, are modestreductions therateof inflation in relatively and will markedly unemployment improvepresidential ratings and hencepublic satisfaction. However, inflation as and unemployment ratesfall,it takes largerand larger reductionsin inflation and unemployment improve to ratingsstillfurther. Because of the steepnessof theindifference curvesat low rates of inflation, the naturalrate of unemployat ment there is little incentiveto a presidentto force down inflation a rateclose to zero. to

361

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