Being a Federal Reserve Chairman must be a lot like refereeing in the NFL. The experts –with the most knowledge and superior vantage points – are perpetually harassed and critiqued by amateurs on the sidelines, most of whom are just searching for a scapegoat to blame for their teams’ failures. To extend the analogy, in an election year with high stakes this is nothing short of a Super Bowl setting for the Fed. Though the Federal Reserve is an independent, autonomous organization, it is still subject to scrutiny, most notably from Ron Paul, chairman of the Subcommittee for Domestic Monetary Policy.
Along with this scrutiny follows political pressure, which Democrats and Republicans constantly claim has become the impetus for the Fed’s actions, or lack thereof. Mitt Romney, along with many congressional Republicans, is on the record opposing further monetary stimulus – a stance that is sure to change should the Republicans win control of the White House and Congress in November.
Boston Federal Reserve President Eric Rosengren has recently advocated for aggressive accommodating monetary policy. He calls for the Fed to continue its purchases of bonds until economic recovery is evident and robust. Rosengren does not believe the Fed’s action should be inhibited by expectations of criticism that such action is intended to benefit Obama – helping the economy is his only concern.
Vincent Reinhart, chief U.S. economist for Morgan Stanley and former influential colleague to Ben Bernanke, concluded that Fed typically stands pat in election years with a tendency towards inaction. 1996, Clinton’s reelection year, stands as an example: the federal funds rate was not changed after January. However, examining the past few presidential elections paints a much different picture – that the Fed, like an NFL referee, makes its decision based on what is correct, in context, whether it is the Super Bowl or a pre-season game; a Presidential election year or a midterm.
In 2000, the Federal Reserve had to contend with the impending burst of the dot-com bubble. Poor policymaking was partially to blame for the extent of the bubble, as the Fed failed to raise rates in advance to slow the glut of investment in the stock market. In addition, on March 21, 2000 the Fed noted that economic conditions remained “essentially the same” despite the fact that the dot-com bubble bust mere days earlier. Nonetheless, the Federal Reserve took appropriate action to cool an overheated economy and raised interest rates in February, March, and May. Containing inflation constrains demand, and adjusting interest rates is the typical , conventional policy tool used by the Fed. The central bank maintained the same federal funds rate from mid-May through the election until the following January.
George Bush’s reelection in 2004 was preceded by a period of meager-to-adequate growth and low inflation. Fed Chairman Alan Greenspan committed to accommodating monetary policy to support economic growth, and kept the federal funds rate at 1% for the first and second quarters. On June 30, the Fed raised the federal funds rate moderately and noted the “policy accommodation can be removed at a pace that is likely to be measured.” In English, this means that one can expect future interest rate increases, which occurred in August and September before the election, and after in November and December of 2004.
2008 will be synonymous with monetary stimulus just as 1848 is with European revolutions. The Federal Reserve emptied its toolbox, with measures that ranged from traditional (lowering the federal funds rate) to unprecedented (TAF, TSLF, PDCF, etc.). The federal funds rate was cut drastically multiple times in January, and such reductions continued through April. Abruptly, and a little absurdly, the Fed had false confidence in their effectiveness of its expansionary monetary policy, and rates were unchanged from June to September. Evidently, the Fed dissuaded from action during this period by the political pressures that come with an election year. The central bank cut rates substantially two times in October, just prior to the election. Thus, pundits who claim the Federal Reserve is gun-shy during an election year have surely misread the Fed over the past three elections.
Likewise, Ben Bernanke will not be deterred from action by a year that features February 29. In a previous post, I briefly outlined some reasons why the Fed has been silent lately: to save tools for potentially adverse events on the horizon, and to maintain the attractiveness (and safety) of US Treasury bills and bonds. Economists predict a third round of quantitative easing (QE3) in September to lower long-term interest rates, which encourages consumer purchases of durables and makes mortgages more affordable. No doubt, the Right will scream that the continued monetary stimulus is a contrived attempt to hand the presidency to Obama, the Left will clamor that more monetary expansion is required, and that Bernanke has tilted the playing field towards Romney. Both will be off-base.
The effects of policy changes by the Federal Reserve after May will not manifest themselves before November. Time is necessary to consumers to alter their behavior in a response to interest rate changes and for the Fed’s intended results to materialize. This time period is known as the monetary lag. For instance, if the Fed raises its target for the federal funds rate, it takes time for open market operations to be executed so this target is reached. In addition, the rational consumer, when faced with a rise in interest rates, will not necessarily forego a major purchase if he or she anticipates interest rates will rise again in the short-term future. Thomas Hoenig, the Kansas City Federal Reserve President, claims that the monetary lag is 6 to 9 months (at times, 1 year) before implemented policies reach their peak impact. If the Fed were interested in manufacturing a victory for Obama, the time to act would have been from September of 2011 through the first quarter of 2012 in order to give monetary stimulus appropriate time to achieve demonstrable economic effects.
Side Note: ironically, Operation Twist fits this description mildly well. This policy, whereby the Fed sells short-term bonds and buys bonds of a longer maturity in an attempt to drive down long-term rates, was instituted September 21, 2011, two days after GOP leaders urged the central bank to take no action to stimulate the economy.
Dallas Federal Reserve President Richard Fisher, a consistent inflation hawk, displayed ignorance as to the role of monetary lags by suggesting inaction, as a way to avoid raising “the political tension that surrounds the central bank.” Meanwhile, Senator Charles Schumer (D-NY) called the Fed “the only game in town” in the election year, beseeching Bernanke for more monetary stimulus. Criticism of the Fed’s (in)action in the months leading up to an election ignores the reality of monetary lags. So too do calls for Federal Reserve action stimulate the economy out of dire need and poor conditions – this misplaced blame fails to recognize the true culprits for the paltry recovery.
The Federal Reserve cannot and should not be the scapegoat for the 112th Congress, which has enacted just 151 laws. In comparison, the 110th Congress passed 460 laws despite divided control of the legislative and executive branches. The Tea Party conquest of Congress has engendered partisan gridlock through the GOP’s aversion to compromise and blind commitment to ideology.
The Republican party deserves the lion’s share of the blame for why fiscal and monetary stimuli have not been instituted. The GOP’s fanatical desire to return us to a Galtian world necessarily entails massive cuts in spending in all areas not ending with “ilitary.” The Ryan budget is an exhibition of contractionary fiscal policy, otherwise known as austerity.
Economics 101: fiscal and monetary policy are most effective when they are working hand-in-hand.
Until November, expect business as usual for both fiscal and monetary policies – far from hand-in-hand, they’re waging a vicious thumb war.
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