The Fed seems to care about inflation much more during Democratic administrations


Central banks are independent from politics, but are central bankers? In other words, does the Fed do more to juice the economy when one party controls the White House than the other? That's the question University of Michigan professor William Clark asks, and his answer is a statistically significant, though qualified, yes -- the conservative folks who tend to run central banks seem to prefer conservative politicians.

Let's consider the evidence. Rather incredibly, interest rates have fallen over the course of every Republican term and risen over the course of every Democratic term ever since the Fed became independent in 1951, excluding Dwight Eisenhower and Barack Obama, as the chart below shows. That's a hell of a coincidence.

As Clark puts it, the Fed sure looks like a "conditional inflation hawk" -- that is, it cares about inflation more during Democratic administrations and about helping the incumbent win reelection during Republican administrations. The idea here is central bankers prefer Republican policies, so they aren't quite as vigilant about inflation right before Republican presidents face reelection. In other words, the Fed keeps interest rates lower than they should for Republicans. The numbers seem to bear this out, as Clark finds a statistically significant relationship between Republican administrations and the Federal Reserve's benchmark rate.

This data-crunching certainly seems damning, but the reality is it doesn't prove as much as it appears. Maybe it is just a coincidence, and the Fed hasn't deviated from its regular policy rule. Or maybe it has to do with each Fed Chair preferring the party that originally appointed him, rather than systematic bias. Or it could be a few outliers making this effect look significant when it's really not. Clark controls for all of these factors, and the results should give us pause before running out and calling the Fed a partisan stooge. Let's consider them in turn.

-- Inflation and the output gap. The fundamental question is whether the Fed is acting differently than it should be acting when Republicans are in office. Clark looks at inflation and the difference between the economy's size and its potential to control for what the Fed should be doing, and though he finds the relationship between Republican presidents and Fed policy still holds in both cases, it's not statistically significant for the output gap.

-- Party of the Fed Chairman. It's intuitive that a Fed Chairman would keep interest rates lower for the party that appointed him, but it's intuitive and wrong. Clark didn't find any relationship in this case.

-- Blame it on Volcker? Interest rates increased during Kennedy, Johnson and Clinton's terms, but they really increased over Carter's four years. Maybe that's skewing the results? Clark's results were still robust when he excluded them, but much less so. It would probably be even less so if Clark left out Arthur Burns, who Richard Nixon famously bullied into lowering rates in the run-up to the 1972 election.
The Fed hasn't done more to bring unemployment down, but it has done less to bring inflation down for Republicans. But this is a bit misleading. We can divide the history of the Fed over the past five decades into two eras: Before Volcker and After Volcker. The first period was a time of increasing inflation and increasing interest rates, although the Fed didn't quite know what to do about the odd economic beast that was stagflation during the 1970s. Between the Fed's confusion and Nixon browbeating Burns, monetary policy was far too loose through most of the decade. Then came Volcker. He hiked rates far higher and kept them there far longer than any policy rule would suggest in order to wring the inflationary expectations out of the economy -- a point Evan Soltas has made in great chart form. Since then, it's been a period of decreasing inflation and decreasing interest rates, although rates did go up during the tech boom, as you would expect.

In other words, there hasn't been a persistent bias -- though there may have been in the 1970s -- and both parties have plenty of reason to say the Fed has helped their political opponents. Remember, George H. W. Bush blamed Alan Greenspan for his loss to Bill Clinton in 1992 after Alan Greenspan didn't lower interest rates further, and, more, recently, Mitt Romney probably isn't too happy with Ben Bernanke for launching a new bond-buying program so close to election day. And in both cases, it was a Republican-appointed Fed Chairman arguably acting against the interests of a Republican candidate.

Central bankers are human, and like the rest of us humans, they have political preferences. Sometimes -- ahem, Alan Greenspan -- they act on those preferences, but for the most part they do not, at least in the post-Volcker period. Central bankers are technocrats first, humans second.