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Will the US presidential elections interfere with FOMC decisions?

This topic will be discussed during the Amundi World Investment Forum

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     #AmundiWIF16

THE ESSENTIAL

The start of the monetary policy normalization by the Fed at the end of 2015 has led to an expectation about further rate hikes in 2016. After the market shaken up observed at the beginning of the year, the projections for the fed funds from FOMC members were revised downward for all the horizons but still the FOMC members expect two hikes whereas the markets expect only one. The decision to hike or not and its timing will be impacted by a number of factors, possibly including the US presidential elections. Indeed, it is often argued that the Fed runs a more accommodative monetary policy before the elections.

By looking at the past – elections and monetary policy decisions – we found out that the Fed’s independence was not called into question when the only policy instrument was the fed funds. However, this conclusion is much more dubious during the quantitative easing, an unusual and contentious mechanism. Coincidence or not, the Fed has exhaustively signalized that it is independent and it has fought to keep it like that. Thus, despite all the obstacles it has to face – economic and political-, it may restart the tightening cycle before elections. Partly in name of its independence.

 

 

PUBLICATION

 

Policymakers, academics, and other informed observers around the world have reached broad consensus that the goals of monetary policy should be established by the political authorities, but the conduct of monetary policy in pursuit of these goals should be free of political influence.1

 

The influence of politics in the economy is an ever present issue and has been regularly the object of debate in the literature for decades. In particular, since the mid-seventies political economists have tried to assess whether politicians try to somehow manipulate fiscal and monetary policies with the aim of being re-elected and remain in power. The called Political Business Cycle literature has evolved since then and there is a large branch in particular interested at evaluating the implications of political pressures on monetary policy decisions in particular for developed economies2 and especially in an election year.

This theme is particularly interesting as the US presidential elections are approaching (November 8th). The two main political parties are very likely to choose Donald Trump and Hillary Clinton as candidates (the national conventions are going to take place on mid-July). The economy remains the n°1 issue that the Americans want their future president to address in priority. The main candidates have already exposed some proposals to review the tax
code, which will directly impact the economy progress after elections. Table 1 shows the tax proposals of both candidates.

2016-06-03-tab-1

 

The 2016 presidential elections come at a tough period for the Fed, which experienced some difficulties to start its monetary policy normalization. The projections for the fed funds of FOMC members (the so called ‘dots’) have been downgraded repeatedly and the fed funds liftoff (that took place in December) has been postponed many times. For the time being, the FOMC members expect two rate hikes in 2016 whereas the markets expect only one. The need or not to hike the fed funds again has caused a lot of ink to flow, as there are numerous obstacles for the Fed: relatively low growth, British vote on the European Union, depreciation of the renminbi whose timing is difficult to catch. Obviously, a big question is: will the elections interfere in FOMC decisions?

While the Fed constantly reaffirms its independence (as in the quote above), the subject is an ongoing topic of controversy. Some recent studies have suggested that the FOMC is more accommodative during the year prior to presidential elections “all other things being equal”3. However, it is important to note that these papers used old data sample and focused on periods where the main tool of monetary policy was the fed funds.

Against this backdrop, we decided to highlight some objective facts about the FOMC decisions during election periods. In Tables 2 and 3, we show all the FOMC decisions taken 6 months before and 6 months after the presidential elections and the mid-terms elections respectively. We highlighted below some key elements:

  • The 1992 presidential elections took place at the end of an easing cycle.
  • The 1996 presidential elections took place during a period of stability of the fed funds. It took 6 months for the FOMC to hike the fed funds (a one-off).
  • The 2000 presidential elections took place at the end of a tightening cycle and before the beginning of an easing cycle.
  • In 2004, the presidential elections did not prevent the FOMC from continuing its tightening cycle.
  • In 2008, the presidential elections did not prevent the FOMC from continuing its easing cycle but the policy tool changed after the elections: rate cuts before the elections, QE1 after the elections.
  • In 2010, the FOMC announced the QE2 program the day following the midterms elections.
  • In 2012, the FOMC decided to purchase MBS one month before the presidential elections and added US Treasuries to the monthly purchases one month after the elections (QE3).
  • In 2014, the mid-terms elections took place after the year-long period of QE3 tapering.
2016-06-03-tab-2
2016-06-03-tab-3

All in all, it seems that political calendar does not seem to affect so much the timing of the Fed’s monetary policy decisions. Objectively, during the period in which monetary policy was mostly conducted through the fed funds, we do not observe any particular hesitation by the Fed nor to increase nor to ease monetary policy. It mostly carries on with what it was doing. However, this fact seems to be less clear during QE times, the QE policy being a much more controversial tool. Republicans were especially aggressive against the extension of such policy instrument. Hence, the fact that QE1 was announced just after the 2008 presidential elections (beforehand, there were only rate cuts); or that the QE2 was launched the day following the November 2010 mid-term elections (despite the existence of consensus in the market about the need of further easing by the Fed before this date); or that the QE3 was announced in two steps (MBS before 2012 presidential elections, UST afterwards); or that the Q3 was ended just before the 2014 mid-term elections of 2014 make us to raise some questions whether some decisions have been deliberately announced after the elections or whether is was only a matter of coincidence.

The Fed has been at the center of the political debate over the last quarters as several Republican candidates called for restraining the Fed’s independence and presumptive Republican nominee Donald Trump clearly said he would remove Fed Chair Janet Yellen if elected. And pressure also arises from the Democratic side: the main presidential candidates, Hillary Clinton and Bernie Sanders, want to prevent bankers from serving the boards of the Fed’s 12 regional banks and to include more labor unions leaders and farmers in its leadership. Moreover, the House of Representatives passed the bill HR3189 “Fed Oversight Reform and Modernization Act” in November 2015, requiring the Fed to establish a mathematical formula or “directive policy rule” that would dictate how the FOMC adjusts the stance of monetary policy. Janet Yellen is against this proposal.

As the Board of Governors and Fed employees seem closer to the Democrats and the Fed’s independence is heavily questioned by the Republicans, FOMC members want more than ever show their political neutrality and they will probably not let the elections interfere with their decisions. Over the last months, the Fed made huge communication efforts to claim that it is independent ("Does the Fed get audited?" is the main thing you see when you visit the Fed’s website). Especially, St. Louis Fed president James Bullard stated recently that "I don't think a change in the White House either way will affect Fed policy," and that "My hope is that neither campaign is interested in politicizing the Fed." This could be one of the reasons for which the FOMC could continue its tightening cycle before the elections.

 

1 http://www.federalreserve.gov/faqs/why-is-it-important-to-separate-federal-reservemonetary- policy-decisions-from-political-influence.htm

2 For more information on the Political Business Cycles see i.e. Norddhauss, W. (1975), Rogoff, K. (1990) and Alesina et al. (1992).

3 See i.e. Abrams, B. and Iossifov, P. (2006) and Funashima, Y. (2013).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Objectively, during the period in which monetary policy was mostly conducted through the fed funds, we do not observe any particular hesitation by the Fed nor to increase nor to ease monetary policy. However, this fact seems to
be less clear during QE times, the QE policy being a much more  controversial tool

 

 

 

FOMC members want more than ever show their political neutrality and they will probably not let the elections interfere with their  decisions

 

 

 

 

 

 

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Bastien DRUT, Strategy and Economic Research at Amundi
Roberta FORTES, Strategy & Economic Research
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