The Fed and Election-Year Politics

Since June, 1999, the Federal Reserve Board has moved to tighten short-term interest rates six times. The Fed-funds rate now stands at 6.5%, the highest level since 1991. The Fed's Open Market Committee declined to change the target rate at its meeting in June, 2000 and again at its August meeting. Conventional wisdom holds that political heat influences the Fed to refrain from interest rate movements in the months preceding a Presidential election. Newspapers, including the Wall Street Journal, widely reported bi-partisan pressure on the Fed prior to its meeting in June to refrain from further hikes. Fifteen house democrats, including some of the party's highest ranking members sent a letter to Chairman Greenspan warning that further rate increases would be "politically unwise and morally unacceptable." Will politics force the Fed to stand pat until after November?

The answer is "probably not", according to an article by Goldman Sachs economist Rajib Pal. Analysis of Fed policy changes from 1972 through 1999 yields the following conclusions:

• Fed policy changes are not less frequent in election years. During the 18 year observation period, the Fed changed monetary policy 7.9 times during election years compared to only 7.3 times during other years. Further analysis by month shows that the Fed has a higher tendency to change policy during March of an election year, as compared to non-election years, but in all other months, the differences between election and nonelection years are statistically indistinguishable.
• Fed tightenings are not rare during election years. Between 1972 and 1999 the Fed tightened monetary policy an average 4.9 times during election years, compared to 3.9 times during non-election years. March and December are the two months in which tightening is more likely in an election year than in a normal year.
• The Fed attempts to avoid only tightening moves late in election seasons.
• These conclusions do not change materially in the Greenspan era.

As it happens, the Fed's Open Market Committee did not tighten monetary policy at all in 1992 and 1996 because conditions did not warrant, although it did tighten eight times during 1988. The author concludes that economic considerations trump election-year politics in shaping Fed policy. It's possible that the timing of economic news this fall with regard to signs of inflationary pressures could trigger an interest rate move just prior to the November elections, despite conventional wisdom and Congressional saber rattling. At the moment, most analysts don't see the need for tightening in the near future based on economic data, but the Fed is not likely to hesitate if bad news emerges in the next 6 weeks.