Sorry, Trump, Fed Policy Actually Favors You
As Donald Trump charges that the election is being rigged, let’s consider one of his claims: that Janet Yellen and the Federal Reserve are keeping the economy artificially strong to benefit the candidacy of Hillary Clinton. While Trump is correct that the Federal Reserve system is subject to some political influence, the rest he gets mostly backwards. If anything, Fed monetary policy has weakened the electoral prospects of the Democratic Party since the financial crisis.
Economic research on “political business cycle theory” asks whether the central bank times its stimulatory actions to boost the reelection prospects of incumbents, typically by creating a pronounced upswing coming into November. It is well known, for instance, that in the early 1970s, President Richard Nixon pressured Fed Chairman Arthur Burns to goose up the money supply. But since then, it is less clear what general pattern holds, and in 2008, economic policymakers could not stop a crumbling economy from hurting the chances of John McCain, the presidential candidate of the incumbent Republican Party.
As for today, I do see an influence of politics on monetary policy that tends to keep the Fed from moving outside the boundaries of what is broadly considered to be politically permissible. For instance, if the Fed were to consider raising its price-inflation target from 2 percent to 4 percent, which some economists think would be a good idea, I believe pressure from Congress would induce the Fed to drop this idea. American voters have a strong dislike of inflation, perhaps because they fear, correctly or not, that their wages will not keep pace with price increases.
The reality is that Congress and the president could take away the Fed’s (partial) monetary-policy independence at any time, so it is wrong to think of the Fed as a purely autonomous institution.
That said, within a broad range of options the Fed’s policy decisions are governed by economic debate and technocratic analysis, not by politics. What politics has discouraged the Fed from doing is to consider a more stimulatory, higher-inflation approach to monetary policy during the recovery period. In other words, Fed decisions possibly have made the economic performance of President Barack Obama look less effective than otherwise might have been the case.
I cannot here resolve whether more inflationary stimulus actually would have helped the American economy recover more quickly. It’s enough to say that politics dissuaded the Fed from looking too seriously at administering economic jolts with looser money and higher inflation, and in fact the Fed has been undershooting its 2-percent inflation target since the financial crisis.
Republican politicians are fond of citing the Reagan economic recovery of the 1980s, and noting that the U.S. economy bounced back more rapidly than it has under Obama. They are less fond of reminding their audiences that annual price inflation in the 1980s averaged over 5 percent, and that may have aided the recovery by easing credit flows and lowering real wages, thereby inducing higher employment.
Overall, Republican legislators are less comfortable with higher inflation than Democratic lawmakers. In other words, political constraints, to the extent they have had influence, have pushed Fed monetary policy closer to the views of many Republicans than to Democrats. That is not because the Fed is partisan, but rather because it simply cannot afford to alienate the public too much.
The forecasting model of Ray Fair of Yale University is based on economic data, and it has had a stellar record in predicting past presidential elections. This time around it is picking the Republican candidate to win, and if that is proven wrong (as most of us expect) it will be for candidate-specific and also cultural reasons, not because the economy is overwhelmingly strong. It certainly won’t be because of the Fed.
In response to Trump’s irresponsible charge about Yellen herself, I’ve seen some of my fellow economists overstate the political independence of the Fed. The reality is that the Trump candidacy itself may have received an unintended boost from the political influences on monetary policy.
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