Fed and the Elections: Oh, What a Tangled Web…

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…When First We Practice to Appease

One of the big debates around the Fed these days is how the election will impact the timing of Fed policy changes. In my last piece I argued that the Fed is politically independent in that it does not favor one party over the other or favor incumbents over the opposition party. However, even if the Fed tries hard to avoid biasing the election result, it may want to keep a low profile during the election, staying out of the spotlight as much as possible. Hence we could expect a policy “blackout period” around the November 5th election day.

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While this makes some sense on the surface, in practice it makes no sense for two reasons. First, the economy does not stand still for an election year and that is particularly the case this year. The Fed is grappling with three policy transitions. First, is inflation returning to target or will it get stuck above target? Second, is the economy slowing significantly or will it remain robust? Third, and related, is the current policy rate much higher than its equilibrium value? The Fed can’t credibly put aside these considerations and let the election determining the policy path.

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The second reason the Fed does not have a blackout period is that no matter what they do they will be severely criticized. Former President Trump, and hence most of the Republican Party, have already determined that any cut by the Fed would constitute an attempt to favor Democrats in the election. No amount of explanation or analysis is going to alter that conclusion. On the other side of the aisle, Democrats in Congress have already made clear that they will only be satisfied if the Fed cuts many times. For example, at his bi-annual “Humphrey Hawkins” testimony, Rep Sherman (D-Calif.) told Powell “My goal here is to convince you to cut more and sooner.” To his credit, President Biden has stuck to the old tradition of not overtly attacking the Fed. The Fed has two choices here: (1) do the right thing and face massive criticism or (2) do the right thing and face massive criticism.

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Looking nonpolitical, while focused on the election?

With this in mind, let’s take a look at some of the popular narratives around the timing of rate cuts. A common view is that the Fed will avoid policy changes during or after the conventions in July and August. Taking this a step further, if they are not going to cut at the July or September meetings then delaying to November or December might be seen as political since it would favor Republicans. Hence the blackout period could extend for the whole second half.

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The oblivious problem is that a long hold is going to look very political unless it is supported by the data. The economy is evolving and hence the only nonpolitical path is for the Fed to evolve with it. Unless the data support a long on hold, the Fed will face criticism not only from Democrats, but from impartial observers like yours truly.

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Okay, so perhaps the answer is to cut in June, even if the inflation data suggest waiting until closer to the election. This could be presented as a possible one-time adjustment rather than as part of a string of moves. The Fed could then cut in December and still "get in" two cuts this year. Again, the problem with such a strategy is that it makes the Fed look political. Historically, they have always started rate cycles with the intent of making more than one move. Departing from the normal tactical path would look political.

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In sum, if there is a blackout period, it has to be very short. For example, suppose it takes until November for the data to warrant a cut. That is just two days after the election. If the Fed hasn’t cut by the November meeting, it might not be a very good time to start, as that would be sticking a finger in the eye of incumbents. So maybe they wait until December?? On the other hand, if the November cut is part of a series of cuts, then why not cut again?

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If they talk the talk, they can walk the walk

The good news is that the Fed does not have to play a game of "Twister" around the election. Instead, the Fed is already laying the groundwork for policy flexibility.

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In the good old days of “smoke and mirrors” central bank communication, their critics were justified in questioning the integrity of the institution. The lack of clarity and transparency helped sell a lot of copies of “The Secrets of the Temple” and other conspiracy views of central banks. Fortunately, these days, the Fed has many tools for communication. They are particularly handy in an election year.

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The first tool is the bully pulpit of press conferences, speeches, and testimonies. Powell now opens every post-meeting press conference with a “declaration of independence:”

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“My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people… I want to assure the American people that we’re fully committed to returning inflation to our 2 percent goal. Restoring price stability is essential to achieving a sustained period of strong labor market conditions that benefit all."

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The press conference, testimonies, speeches by Fed officials and even Powell’s appearance on 60 Minutes in February are all opportunities to explain why policy is independent of politics and how the economy is driving their debate and decisions. The public debate among officials over “three or less” also keeps the focus on fundamentals.

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A less obvious, but also important, communication tool is the FOMC’s quarterly Summary of Economic Projections (SEP) and the public discussion around them. In some ways, the SEP is an awkward communication tool. The various forecasts are not based on a common set of assumptions. The summary also does not tell us which economic forecasts are tied to which funds rate forecast. Frankly, I still don’t understand why they don’t “connect the dots.” Hence, Powell seems to have a bit of a love-hate relationship with the SEP, underscoring it sometimes and downplaying it at others.

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Today, he’s loving it. The SEP offers a concrete way to tie the policy path to the economic outlook. The median forecasts for growth, inflation and the funds rate show the economic “reaction function” of the Fed. If growth and inflation do X and Y, the funds rate will do Z. Of course, the range of forecasts and assessments of uncertainty in the outlook gives the Fed flexibility, but not enough for them adopt an election-driven path.

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Not only does the SEP give the FOMC cover for doing the right thing, it creates pressure for them to do the right thing. How can they write down their forecasts and then ignore them if they come true? The result would be even more unwanted attention in an election year. The SEP makes it much harder for political considerations to influence the policy path.

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Put in your earplugs, put on your eyeshades

The bottom line is simple. There is no way to time monetary policy changes without influencing the election. Politicians will blast the Fed no matter what they do so trying to placate them is a waste of time. Hence the Fed will tune out the political noise, focusing on explaining the logic of what they are doing and avoiding surprises. The more consistent they are about the metrics they are looking at, the better. My guess is that they cut in September and December.

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But first: let's see what happens with tomorrow's jobs report...