The Political Business Cycle

The President’s recent pressure on the Federal Reserve is a great illustration of why we must have an independent central bank. Every incumbent politician wants the economy to be growing strongly when he or she is seeking reelection. Now, the current President has suddenly realized that he put in place expansionary fiscal policy too early, stimulating the economy in 2018. He would prefer that the economy be growing more rapidly in 2020 when he hopes to be reelected. But the transitory impact of his policies are already wearing off, so of course he wants the Federal Reserve to cut interest rates now and to further stimulate the economy.

Monetary policy works with a lag, with the maximum impact of a policy change on output and employment occurring about one year after a change in interest rates. That means that if the Federal Reserve were to cut interest rates right now, the economy would be heating up next spring and summer, just ahead of the fall elections.

Economists call the relationship between stimulative policies and elections the Political Business Cycle. Since time immemorial, politicians have striven to have macroeconomic policies help their reelection chances. That is one reason that most countries have created independent central banks, so that economic facts, not political desires, determine monetary policy.

Does the economic situation itself call for a cut in interest rates? Although a few weeks ago there was some concern about weakness in the economies of China and Germany, along with an inverted yield curve, the threat of recession seems to have subsided. In fact, this is exactly the wrong time to engage in stimulative monetary policy, as the economy seems very close to full employment, and further stimulus is likely to be inflationary. Should the U.S. labor market continue to do well, with wage pressures increasing, the threat of higher inflation might lead the Federal Reserve to raise interest rates later this year.

Earlier appointments to the Federal Reserve Board by the President were outstanding: Randal Quarles, Richard Clarida, Michelle Bowman, Marvin Goodfriend, and Nellie Liang, although the latter two were not confirmed by the Senate. Now the President is considering the appointment of two people who are totally unqualified for the job, with no expertise in monetary policy, macroeconomics, banking, or finance. This attempt to stack the Fed with political appointees to do the President’s bidding weakens the institution and is evidence of the President’s desire to create a Political Business Cycle. The Senate should refuse to confirm these candidates, to help preserve the Fed’s independence from political manipulation.

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