It's the economy, Lula! Lessons from a hard-fought victory

Lula won (whew!). Luiz Inácio Lula da Silva defeated Flávio Bolsonaro, son of the former far-right president, by 51.79% to 48.21% of the valid votes. It was the third closest presidential election since the return of democracy in 1989, surpassed only by the narrow victories of Lula himself in 2022 and Dilma Rousseff in 2014. It was also a historic reversal. For the first time since 1989, the candidate who finished second in the first round won the runoff. The victory is a relief for Brazilian democracy. But the fact that he came from behind, and that polls showed a dead heat until the very end, should be concerning.

The remarkable mobilization between the two rounds certainly mattered. The enormous street demonstrations, led in many cases by students and social movements, helped change the political atmosphere. So did the extraordinary social media campaign organized by André Janones, whose Exército do Lula on WhatsApp attracted more than ten million followers. The left demonstrated that it could challenge the far right in the digital arena, and the decline in abstention between rounds suggests that mobilization was critical to the result. These were central elements of Lula's comeback. But they do not explain why the election was so close in the first place. As I argued before the runoff, the fundamental problem was the economy.

Presidential elections are, to a considerable extent, referendums on the incumbent's economic performance. This is the central insight of Ray Fair's well-known econometric model of American presidential elections (more recent forecasts here, but for the house elections). Economic growth, inflation and periods of particularly strong expansion help explain the incumbent party's share of the vote. When the economy is doing particularly well, reelection is highly likely (think Clinton in 1996). When the economy collapses, or inflation is high, incumbents are usually defeated (Hoover in 1932, and Carter in 1980 would be the classic examples). The interesting cases are those in between, when economic performance is neither disastrous nor truly great, and the election can go either way (like Kamala in 2024). Fair's model is estimated for the United States, but the underlying political logic is relevant elsewhere.

That, I would argue, is precisely what happened in Brazil. Lula's third administration improved economic conditions. Employment recovered, the minimum wage increased, social programs were restored, and income tax relief benefited lower income households. Yet the recovery was not vigorous and, even worse, the economy was decelerating in the last year. GDP grew by 2.3% in 2025, and growth over the four quarters ending in the second quarter of 2026 slowed to 1.9%. Brazil was not in a recession, but neither was it experiencing the sustained prosperity associated with Lula's earlier administrations.

The central problem was the renewed commitment to fiscal orthodoxy. Fernando Haddad's fiscal framework, although less restrictive than the previous spending ceiling, continued to constrain the expansion of social expenditure and public investment. The government's determination to reassure financial markets limited its ability to accelerate growth and improve the material conditions of its electoral base. The fights within the PT's coalition about fiscal policy, that I discussed at the beginning of his third term, mattered.

The contrast with Lula's first two terms is instructive. Rising real minimum wages, expanding social transfers and public investment helped sustain growth, employment and the PT's popular support. Conversely, even Jair Bolsonaro understood the importance of putting money in people's pockets. His 50% increase in Auxílio Brasil (the changed name of Bolsa Família during his government) payments in 2022 almost secured his reelection despite the disastrous record of his administration.

The point is not that campaigns, political organization or the defense of democracy are unimportant. Lula's comeback demonstrates exactly the opposite. The mobilization on the streets and online was crucial in an election that could have gone either way. But political mobilization is not a substitute for economic transformation. Better communication can help defend a government's achievements, but it cannot compensate indefinitely for their limitations.

Lula's victory has prevented the return of a political movement that openly challenged democratic institutions after its previous defeat. That is enormously important. Yet another close election, after the equally narrow result in 2022, suggests that appeals to democracy alone cannot guarantee the durability of a progressive coalition.

I hope Lula and the PT (in particular, since Lula, a once in a generation political figure, will not be around any more in 2030) have learned the lesson. The next administration should vigorously expand social expenditures and public investment, pursue sustained increases in the real minimum wage, and substantially raise social transfers.* These are not simply electoral instruments. They are the foundations of a more prosperous and equitable economy, and ultimately of a stronger democracy. Fiscal policy should serve those objectives rather than subordinate them to the demands of financial markets.

Lula has won his last election. The task now is to make sure that the next one need not be so close. It's the economy, Lula!

* I'm happy to have a conversation with those that think that there is no "fiscal space" to do that.

Lawrence Klein author of The Keynesian Revolution has passed away

Lawrence R. Klein (1920-2013)

Lawrence Klein, of Klein-Goldberger US econometric model fame, and author of The Keynesian Revolution (here the Google Books link), and winner of the Sveriges Riksbank Prize in Memory of Alfred Nobel in 1980, has passed away. Klein was a Neoclassical Synthesis Keynesian (often referred to as Old Keynesian now, to distinguish him from the New Keynesians) that made his contribution by developing the empirical applications of the Keynesian model for the US economy.

The seminal work was done in the late 1940s and early 1950s in the context of the Cowles Commission. His book An Econometric Model of the United States, 1929–1952 was further developed in 1955 with his co-author (Arthur Goldberger), published as An Econometric Model of the United States 1929–1952, introduced the celebrated Klein-Goldberger model. The Cowles Commission Model still lives in Ray Fair's macro-econometric model, that maintains essentially the same methodology, resisting to the Lucas critique and the Dynamic Stochastic General Equilibrium (DSGE) models of the Real Business Cycle School (RBC) and their New Keynesian alternatives.

It must be noted that in Klein's original model, expectations did not play a role, since it was complicated to incorporate those, interest rates did not have an impact on investment (basically adopting an accelerator) and that wealth effects (which allow for the Pigou effect, and the return to full employment) on consumption were also absent. So in a sense his model did differ, because of the need to adapt to economic data, from the theoretical versions of the Neoclassical Synthesis, and was closer to heterodox interpretations of Keynes.

Dude seriously, it's the accelerator

Once again I get to discuss on whether investment depends on 'animal spirits', Schumpeterian entrepreneurialism or other confidence fairies. The evidence, as I noted here before, is quite overwhelming in favor of a simple and logical empirical regularity, namely: the accelerator. Below the last results from the Fair Model.

KK is the capital stock, RBA is the bond rate, and Y is income. Note that the coefficient on bond interests is insignificant, both statistically and in economic terms. What drives the change in the capital stock are the contemporaneous and lagged changes in the levels of income (demand). This is not only in the data, but is also quite logical. It says that firms increase their capital stock when demand increases (note that firms have always some spare capacity, so they are looking for permanent increases in demand). If there is no increasing demand there is no need to invest.

Not a surprising result, unless you for some other reason need the Superman theory of investment, in which the firm, the entrepreneur, the job creator is the hero that will save humanity from its mediocrity [have you been reading Ayn Rand again?].

PS: Ray Fair model uses the old Cowles Commission approach to macroeconometrics, which is much better than the new Dynamic Stochastic General Equilibrium (DSGE) models, that rely more heavily on calibration rather than estimation. He discusses the issue here.

Lucas in retrospect

I said it before, but it's worth repeating when one discusses the so-called Lucas' Critique and microfoundations. Lucas and the New Classical Rational Expectations (and RBC) School are the intelligent design of economics. In their view, markets work and this must be the result of some sort of high power, with which mere mortals and governments should not interfere. Lucas and his followers should have the same status as defenders of intelligent design in the scientific community (for the original claim go here).

If you have any doubts go check his paper on what should be the priorities of macroeconomic research just a few years before the crisis (Lucas, 2003), when several heterodox economists had already warned about a bubble and impending crisis. In his own words:

"My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades. There remain important gains in welfare from better fiscal policies, but I argue that these are gains from providing people with better incentives to work and to save, not from better fine tuning of spending flows."

Yes, business cycles problems have been solved, and there is no need for counter-cyclical fiscal policy. And this guy got the Sveriges Riksbank Prize, sometimes referred to as the Nobel!

But the point I wanted to make really is that there is less than meets the eye to the so-called Lucas' critique. The problem for Lucas was that the parameters of macroeconometric models (mostly of the Cowles Commission, CC, or the Cambridge-Levy stock flow with coherent accounting, SFCA, types) were not invariant to policy changes, and could not, in fact, be taken as parameters. Even if you take the neoclassical/marginalist approach seriously (meaning forget its logical problems revealed by the capital debates), as noted by Ray Fair (2012) (one of the last defenders of the CC approach within the mainstream):

"The Lucas (1976) critique says that the coefficients may not be stable if they are based on expectations that change over time or change when a new policy regime replaces an old one. This problem is part of the larger problem of potential coefficient instability, and it may not be the most serious. If expectations are not rational or if regimes do not change very often or by very much, any instability caused by Lucas-critique related issues may be small relative to instabilities caused by other things, like the changing age distribution of the population."

The fact, is that parameters are to a great extent invariant to policy changes, and there are a lot of parametrical regularities in macroeconomics, e.g. Okun's Law, Houthakker-Magee effect, or relations with changes in size that are not dramatic, like the size of fiscal multipliers, accelerator coefficients and pass-through effects, for example. And you can go on, for example, it's not a new thing that expansionary fiscal policy and higher debt levels have almost no impact on interest rates, that is, also, a fairly established macro regularity. That is why one can talk about macroeconomic stylized facts.

And it should be no surprise then, that models that do not use the mainstream assumptions of reversion to mean (to the optimal levels, by the way, the reason why Lucas thought cycles were solved and no macro policies where needed), and that depend on the macro accounting and the proper Keynesian causalities fared better during the last crisis (see here).