The Federal Open Market Committee met Tuesday and, as expected, announced that it was making no changes in its management of the nation’s money supply, though it did hint at the possibility of reducing an interest rate target when it next convenes in late June.
News accounts generally noted that the FOMC decision was exactly what many analysts had predicted. There were few expectations that the committee would lower its Fed funds rate target on Tuesday, and it was clear that economic and political conditions made raising that rate out of the question for now.
What the reports failed to note is the degree to which upcoming FOMC meetings will be held under increasing political pressure. The United States has the most drawn-out political campaigns of any nation in the world. The Iowa caucuses are just 253 days — and five FOMC meetings — from today. The New Hampshire primary follows 12 days later.
The FOMC will meet an additional six or seven times between these initial campaign milestones and the actual 2004 national elections. Decisions made by the nonpartisan, nonpolitical FOMC will be subject to ever-increasing scrutiny, not for their effects on the national economy, but for how they may aid or retard specific presidential candidates.
This is a difficult, but unfortunately unavoidable, arena in which to formulate monetary policy.
It is important to be clear at the outset that the whole Federal Reserve System was designed to be nonpartisan and nonpolitical. In practice, it is highly faithful to that objective. The seven members of the Board of Governors and the five district Fed bank presidents who vote as committee members take a sworn oath to carry out their duties faithfully.
Virtually all historical evidence shows that they take this responsibility seriously. No serious Fed observer would expect anyone in the FOMC to take overt action that might influence a presidential election.
But they will have to meet 12 times, and each time they will have to reach a decision about expanding or constricting the nation’s money supply. What they decide potentially can affect U.S. output, employment, prices and stock markets. Change — or lack of it — in economic measures, especially unemployment, can sway public sentiment for or against either the incumbent president or his Democratic challengers.
The paradox thus is that while the Fed is consciously a nonpolitical entity and its officials may be rigorous in their impartiality, Fed policy inherently and inevitably has political effects. The FOMC will be damned if it does anything and damned if it doesn’t.
This is not true in every election year. When the economy is doing relatively well, as in 1968, 1988 and 1996, no one really cares what the Fed does. But when the economy faces problems of inflation, as in 1972 and 1980, or unemployment, as in 1992 and right now, the heat is on the monetary authorities.
The inevitable human reaction is to err on the side of caution, allowing whatever stance last taken to continue to run from meeting to meeting. The Fed’s history shows it makes few dramatic changes in monetary policy in the six months before a presidential election.
But inaction is still a policy choice. If the FOMC leaves its target for the Fed funds rate the same and output and employment deteriorate, it will be blamed for letting the economy swirl down the drain and for hurting an incumbent president. If it lowers the interest rate target and pumps more money into the economy, it may be criticized for pumping up the economy to favor the president.
This is not idle speculation. Many reputable economists argue that Fed Chair Arthur Burns avoided constricting the money supply until after the 1972 election to avoid hurting his fellow Republican, Richard Nixon. The nation paid for this complacency with higher inflation in 1973 and 1974. This is the one example of alleged electoral favoritism that appears to have some foundation. Burns vehemently denied the charges until his death.
If the economy should improve in the next 18 months, the FOMC may face the question of whether it should raise its interest rate target. Remember that it is keeping short-term rates at 40-year lows by pumping out more and more money. That is not an immediate threat as long as output and employment remain slack, but when economic growth picks up — as it inevitably will — the Fed will have to constrict money growth and raise short-term rates with similar inevitability.
Raising rates is a highly visible act with the potential for all sorts of political spin. George H.W. Bush criticized the Greenspan-led FOMC that kept money relatively tight during the 1992 campaign that put Bill Clinton in the White House. “I appointed him and he disappointed me,” the first President Bush memorably said of Greenspan.
Like a recurring bout of malaria, our nation will increasingly be gripped by the 2004 presidential campaign in coming months. Eventually it will be over. The FOMC will continue to meet about every six weeks and make decisions. But it will not be a comfortable time for the 12 men and women on the committee.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.