Will the Fed Be Swayed by the US Electoral Calendar?
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Will the Fed Be Swayed by the US Electoral Calendar?

Whether and by how much the Fed will raise rates, is being hotly debated. With Presidential and Congressional elections looming over the US, the additional question arises if the election calendar will influence the Fed's decision.

The weak US labor market report for May released on 3rd June has effectively taken a rate hike at the upcoming meeting of the Federal Open Market Committee (FOMC) on June 14/15 "off the table." A keynote speech by Fed Chair Janet Yellen on June 6 also suggested so. If the upcoming labor market report is significantly better, other economic data remains strong and uncertainty over the UK vote on EU membership subsides, a rate hike in July is still a possibility; however, our base case remains that a next hike occurs in September. An important question is whether the US election calendar will have an impact on the Fed's decision.

Fed Decisions and the Electoral Calendar

The last 6 decades were put under a microscope to check if the Fed's decisions were ever influenced by the electoral calendar. Although the data sample is too small to obtain statistically significant results, a close inspection of the data provides a reasonably clear answer.

There are only two or three cases in which Fed policy may have been "different" in the period prior to the Presidential elections than in the period immediately following the elections. The first instance is the 1964 contest between the Democrat Lyndon Johnson and Republican nominee Barry Goldwater. The Fed was on hold for a number of months before the elections but initiated a series of rate hikes immediately thereafter.

This could be interpreted as the Fed favoring the incumbent, i.e. President Johnson, who had taken over in November 1963 after the assassination of John F. Kennedy. However, the evidence regarding the importance of politics is not clear. The rate of inflation had been rising only mildly in 1965, but accelerated in 1966, suggesting that this economic factor may have been the dominant driver of policy rather than political considerations.

Nixon vs. Burns as a Possible Exception

The other two instances are the 1968 and 1972 contests between Richard Nixon and Democrats George McGovern and Hubert Humphrey, respectively. In 1968, the Fed slowed and then halted its hiking cycle before the elections. Once again, economic reasons may have played the key role, however: the US economy entered a recession in December 1969, and inflation slowed as of mid–1970.

The only historically documented case of political interference is 1972. Arthur Burns, who chaired the Fed at that time, reported in his memoirs that President Nixon pressured him to maintain an easy policy stance despite rising inflation. But even then the Fed Funds rate did move up in response to rising inflation.

None of the other instances shown in the chart disclose any change in policy prior to and after the elections. There are periods in which the Fed remained in a phase of cutting interest rates before and after the elections (e.g. George H.W. Bush vs. Bill Clinton in 1992), of keeping the Fed Funds rate on hold before and after the elections (e.g. Bill Clinton vs. Bob Dole in 1996), or in a phase of continued rate hikes (e.g. George W. Bush vs. John Kerry in 2004).

Fed Funds rate and US elections

Federal Funds target rate (%) around US elections

Source: Board of Governors of the Federal Reserve System (US), research.stlouisfed.org 

Appointment Process – A Temptation to Control?

Last month's remark by Donald Trump that he would want to replace Janet Yellen as Fed Chair if he were elected, raises the question whether Presidents can influence Fed policy via the appointment process.

There is little doubt that this process is a very political one, just as the process of appointing Supreme Court judges. However, like in the latter case, there are checks and balances built into the US system, which tend to prevent "extreme" appointments.

The key here is the Senate, which needs to approve Presidential nominees. Given that the Senate is structurally more centrist in its orientation than the House of Representatives because of longer terms and the need for state-wide, rather than only district-wide, majorities, candidates for the Board of Governors also tend to have such an orientation.

…Or a Desire to Stabilize?

Moreover, members of the Board of Governors are appointed for 14-year terms, which provides continuity while, according to the law governing the Fed, the Board must provide a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country."

Finally, while the Chair and Vice-Chair of the Board of Governors are only appointed for 4 years, Presidents typically extend these appointments even if the Fed leaders were appointed by a President from the other party (Note that Paul Volcker was originally appointed by Democrat Jimmy Carter, but reappointed by Ronald Reagan; Bill Clinton re-appointed Alan Greenspan who was originally appointed by Reagan; and Ben Bernanke was appointed by George W. Bush but then re-appointed by Barack Obama).

Enough Other Things to Worry about than Politics

All in all, the data suggests that the electoral calendar does not play a significant role in Fed policy. The key decision factors for Fed policy makers are their outlook for employment and inflation, as defined by the Fed's "dual mandate." Global factors and financial stability play an important role as well.

Political developments in the USA or elsewhere would only be a decision factor for the Fed, if they were to affect financial stability, and thereby, economic outcomes.