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Tue June 12, 2012
The Fed's Tough Job Gets Harder In Election Year
Americans who fear the economy is losing steam would like to see the Federal Reserve turn up the heat.
That might happen when the central bank holds its next meeting June 19-20. The Fed could take steps to drive interest rates even lower, or create fresh piles of cash to stimulate growth.
But with the election season gearing up, the Fed's ability to act boldly may be restrained. That's because the monetary policymakers want to preserve the Fed's credibility as a nonpartisan entity.
That's tougher to do when political battles are raging, according to Ann Owen, a professor at Hamilton College and a former economist at the Fed.
"Whatever they do now, it will be seen in a political light," Owen said. "If they stimulate the economy, they'll be accused of trying to help President Obama. If they don't, they'll be seen as helping defeat him."
It's a classic case of "damned if you do; damned if you don't," she said.
The Fed's job is to stimulate economic growth without unleashing inflation, and do it all in a way that does not favor one political candidate or party over another.
Operating In A Hostile Environment
A review of the historical record shows the central bank does not change its monetary policies ahead of presidential elections, Capital Economics, a research firm, told its clients last month. For example, during the peak of the financial crisis in the fall of 2008 — the last presidential election year — the Fed continued doing what it thought best for the country.
But the economics firm warned that this year may be more politically charged because "hostility towards the Fed is currently high." The Fed acts as an independent entity. But it also is a creation of Congress, which means lawmakers could alter the Fed's structure or mission.
During the primary season, candidates who ran for the Republican presidential nomination roundly criticized the Fed for its various policies and actions, and many Republicans in Congress continue to have harsh words for it.
For example, many conservatives and libertarians fear the monetary stimulus has increased the risk of inflation. And earlier this year, conservatives were not pleased when the Fed issued a report saying federal aid to homeowners could help boost the housing market, even if the help came at taxpayers' expense.
That prompted Sen. Orrin Hatch, R-Utah, to write an open letter to the Fed, warning that it should "refrain from providing any hint of activism" in the political sphere. He said the Fed made "a move in the wrong direction" by supporting a tax-related policy, rather than sticking to monetary policy.
David Barker, another former Fed economist, said the Fed is "not influenced by raw politics"; that is, it doesn't get hit by Congress or the White House with specific demands for particular actions. "There is pretty good evidence that in the Nixon years, there was direct pressure on the Fed to act ... but it's not likely to happen in such a blatant way these days."
Recognizing Political Realities
Still, "board members are not immune to the political environment," Barker said. They know that Congress has the power to rewrite the rules that guide the Fed, he said. And Fed Chairman Ben Bernanke's term expires in January 2014, so he would need to begin seeking congressional support next year for a smooth reappointment.
"Bowing to direct political pressure is one thing," which is extremely unlikely, Barker said. "But that's different from recognizing there are political realities," and that it's best to avoid battles with Congress in an election year.
Owen said that when the Fed took aggressive steps in the 2008 financial crisis, it didn't generate as much political heat. At that time, "they were taking specific actions in response to specific problems" as financial institutions melted down, she said.
In 2012, with the economy growing for the third straight year, taking stimulative steps just before an election may seem more suspect, Owen said. "It's less clear cut now that we are in a crisis," she said.
Even aside from its desire to avoid presidential politics, the Fed has another reason to lie low for now. Congress is facing a so-called "fiscal cliff" at year's end as various tax breaks expire and automatic spending cuts kick in.
Congress needs to address this "cliff" or risk disrupting the economy. Given the partisan rancor in Washington, those negotiations may not go well.
Capital Economics says that's a compelling reason for the Fed "to keep its powder dry" for now and then stand ready to fire "in case the U.S. hits a fiscal cliff in early 2013."
The Fed's Options
Last week, members of Congress tried to get Bernanke to say whether, in coming months, the Fed would make use of either of these two options:
1) Continue "Operation Twist," in which the central bank sells short-term government bonds and buys long-term ones. That has the effect of lowering long-term interest rates. People who are trying to sell homes — and want low rates on mortgages — would certainly like to see that operation extended.
2) Launch another round of "quantitative easing," the practice of buying up long-term bonds on the open market. The Fed has done such "easing" twice in recent years to effectively add more money to the economy. With the global economy weakening and commodity prices falling, more and more economists think a third round is becoming necessary.
Taking either path would very likely anger some conservatives. At the congressional Joint Economic Committee hearing last week, Vice Chairman Rep. Kevin Brady, a Texas Republican, said to Bernanke: "It's my belief the Fed has done all that it can do and perhaps done too much. Further quantitative easing won't stimulate growth and create jobs. There exists a real risk that the massive amount of liquidity the Fed has already injected into the economy could trigger higher inflation before the Fed can execute its exit strategy."
But Chairman Bob Casey, a Democrat from Pennsylvania, was seeking reassurance that Bernanke would act in coming months. "Is the Federal Reserve planning to take any additional actions in the short term to spur economic growth and create jobs?" he asked.
Bernanke's response was as nonpolitical as he could make it: "Obviously, I can't directly answer your question; it's too soon for me to do that."