The risk premium hypothesis

Karl Smith writes:

A striking empirical regularity is emerging. The US economy experiences better growth and less inequality under Democratic presidents.

Like Paul Krugman I have typically dismissed this as a likely statistical aberration because I could not think of how presidents, democrat or otherwise could affect the economy in the near term. Unlike Paul I have spent most of my life as a Republican and so I have been somewhat hesitant to accept the regularity as well.

However, the data is the data and until it is overturned it is up to us to explain it.

I should not that in the finance literature I have also seen articles purporting higher returns in equity markets during democratic administrations – so it doesn’t seem to be class warfare.

My Guess: Lower risk premiums.

What the President can do in the short term to benefit wages and equity prices is reduce risk. If the President handles national and international crises with more adeptly then we should see lower risk premiums, and a greater investments in capital and labor. This should drive up equity prices and wages.

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There’s actually some empirical support for the equity prices part. Here’s what Stock Trader’s Almanac 2005 had to say on the subject back in 2005:

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