The depoliticization of monetary policy: a contemporary test of persistent myths

Business Economics, April, 2008 by Jerry H. Tempelman

In the past thirty years, it has been claimed that Republicans tend to favor relatively restrictive monetary policy while Democrats favor relatively accommodative monetary policy. Another claim is that, regardless of which political party is in power, monetary policy tends to be relatively restrictive during the first two years of an administration and relatively accommodative during its final two years. The present paper finds an absence of empirical evidence supporting either claim by restricting the sample period to the past quarter century (1982-2006). The depoliticization of monetary policy decisions probably reflects, among other factors, both the post-1970s new-Keynesian consensus in macroeconomic theory and the realization of political independence of the Federal Reserve System during the Volcker-Greenspan years.

In the past thirty years, essentially two claims have been made about the political contents of monetary policy. First, as discussed below, it is claimed that Republicans tend to favor relatively restrictive monetary policy while Democrats favor relatively accommodative monetary policy. Second, also discussed below, it is contended that monetary policy tends to be relatively restrictive during the first two years of a political administration and relatively accommodative during the final two years of an administration, regardless of which political party occupies the White House.

These types of claims continue to recur in popular opinion, and corporate economists often have to address concerns by senior management that the Federal Reserve helps to elect the U.S. president. These concerns persist, even though the dominant philosophy behind U.S. monetary institutions has been that monetary policy should be independent of political considerations, given that politics is notorious for its short-term focus. Former Federal Reserve chairman Alan Greenspan (2007, p. 478) observes in his memoir that "[d]uring my eighteen-and-a-half-year tenure, I cannot remember many calls from presidents or Capitol Hill for the Fed to raise interest rates. In fact, I believe there was none." But sound public policy decisions often require taking into account longer-term consequences. Inflation, for example, is a phenomenon that tends to creep in over time, requiring perennial vigilance even when a short-term perspective would appear to permit a more accommodative monetary policy.

To some extent, the fact that an element of politics enters monetary policy is inevitable. U.S. presidents tend to appoint Federal Reserve chairmen and governors of their own political party affiliation. Ben S. Bernanke and Alan Greenspan, both Republicans, were initially appointed by Republican presidents (George W. Bush and Ronald Reagan, respectively). Paul Volcker, a Democrat, was initially appointed by Jimmy Carter, also a Democrat. Still, both Volcker and Greenspan were reappointed by presidents of the opposite political party (Volcker by Reagan, Greenspan by Bill Clinton), albeit in part because administration officials apparently felt that to not reappoint them when the financial markets believed they were performing well might have had a negative impact on financial markets that would have reflected poorly upon the administration.

The willingness to reappoint Federal Reserve chairmen despite political affiliation notwithstanding, the two claims of non-independence--party bias and timing bias--remain issues of debate in the research literature. New evidence of party bias was recently presented by Chappell et al. (2005) for the 1966-1996 period. A variation of timing bias was recently offered by Abrams and Iossifov (2006), who found that from 1957 to 2004 monetary policy became more accommodative prior to U.S. presidential elections but only when the Federal Reserve chairman and the incumbent president belonged to the same political party. (2) Hellerstein (2007) finds that from 1973 to 1998, the Federal Reserve has been reluctant to tighten monetary policy in years that precede a presidential election relative to other years with comparable internal economic forecasts.

Some of the methodologies used in the academic literature to find political patterns in monetary policy decisions are less than fully persuasive. For example, the Federal Open Market Committee (FOMC), which determines monetary policy, consists of the seven members of the Board of Governors of the Federal Reserve System and five Federal Reserve Bank presidents. (3) Of these two types of members, only the former are politically appointed. Federal Reserve Bank presidents are appointed by the Banks' boards of directors and tend to adhere to a strict protocol of not revealing or acting on their political preferences while in office. Thus, votes cast by the latter are usually excluded from analyses of political bias. But this means that any pattern attributed to the political affiliation of the governors applies to only a portion of the FOMC's overall voting behavior.

The objective of the present paper, however, is not to reassess the legitimacy of these two claims at the time they were initially advanced, but rather to evaluate whether they are supported by the empirical evidence accumulated since that time. Even if one were to stipulate that these claims were once accurate, much has clearly happened over the past 30 years in the macroeconomic environment, in economic theory, and in the way in which monetary policy is conducted, making it worthwhile to revisit to what extent monetary policy is affected by political considerations.