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

Business Economics, April, 2008 by Jerry H. Tempelman

All in all, the notion that monetary policy tends to be relatively restrictive during the first two years of an administration and relatively accommodative during the final two years of an administration is not supported by the FOMC policy record of the past 25 years. For only seven out of these 25 years, or 28 percent, does the theory accurately predict actual monetary policy decisions. For ten out of 25 years, or 40 percent, do the actual directions of monetary policy clearly contradict the theory's prediction. For eight out of 25 years, or 32 percent, the evidence is inconclusive. Thus, for more than 70 percent of the sample period, there is insufficient evidence to confirm PBC theory. It should be clear that the political business cycle, assuming it once existed in the first place, has disappeared in the United States during the past quarter century. (10)

To be sure, my sample period is limited relative to that of others. But arguably this is a positive. In general, one would expect conclusions to be more robust the larger the sample size. But if the evidence stems from a time-series, averages can be less than insightful if they obscure changes in trends during the sample period. Furthermore, along with the lack of political correlation in dissent votes found in the previous exercise, it would appear to be reasonable to argue that politics has largely disappeared from monetary policy, and the more interesting question becomes not whether but why this has become the case.

3. Conclusions

One reason for the disappearance over the past quarter century of a political business cycle or a political monetary cycle--assuming that one existed in the first place--could be that the theories were posited in the first place. Federal Reserve Board members are said to have become particularly conscious of not being perceived as administration instruments once PBC and PMC theories had begun to be advanced in the mid-1970s: "As a group, the governors had become extremely sensitive to the long-standing accusations that they manipulated the money supply in election years in order to insure a growing economy and help the incumbent party win re-election...Monetary policies during presidential election years was a tender subject for officials at the Federal Reserve" (Greider, 1989, pp. 213-214).

However, some more important factors may have been at work as well. The decline in political contents of monetary policy decisions probably reflects, among other factors, both the post-1970s neo-Keynesian consensus in macroeconomic theory and the realization of political independence of the Federal Reserve System during the Volcker-Greenspan years.

Economic Consensus

In early 2007, Federal Reserve Bank of St. Louis President William Poole was asked whether he was concerned that the then relatively high degree of personnel turnover at the FOMC might lead to a discontinuity of monetary policy. He answered that he thought it would not, in part because, unlike in the past, there was currently "no ringing dispute" among macroeconomists as to the function and methodology of a central bank (Norman, 2007). But, as Poole noted, this had not always been the case.