What stocks to invest in = politics and the Federal Reserve



What stocks to invest in

In my post last Friday on the Labor Department’s most recent Employment Situation report, I commented that I thought it unlikely that the Fed would raise short-term interest rates before the election in November.  How so?   …because the Fed worries about accusations that it would be intruding into the electoral process.

A reader commented that he thought such worries would be silly, either on my part or the Fed’s or both.  I thought I’d respond here.

I agree that it makes little difference for the economy whether the Fed Funds rate is at 0.25% or 0.50%.  In fact, one could easily make the argument that extreme money stimulus is no longer needed and that the US would be better off with higher rates rather than lower.

 

A generation ago, when controlling nominal short-term interest rates was the Fed’s sole policy tool, it was the norm for the sitting President to pressure the Fed in an election year to lower rates, or refrain from raising rates, in order to keep his party in power.  It was also normal for the Fed to acquiesce.  Monetary policy lore says that Gerald Ford was the first president not to do so–and he lost his reelection race.  This behavior also gave rise to the belief that an election year would usually be an up year for stocks, followed by difficulties during the first year of the next term, as the new president removed the extra stimulus.


 

The appointment of Paul Volcker as Chairman of the Fed with a mandate to get the runaway inflation of the late Seventies under control changed this situation, making the Fed the de facto government mechanism for implementing economically necessary but politically toxic decisions to slow the pace of growth.

 

Seeking not to return to its role as a tool of one political party or another, the Fed seems to outsiders to have developed a rule that it will not act within, say, four or five months prior to a presidential election, to either raise or lower rates.  One might otherwise argue that it is giving an economic boost to–or at least signalling its approval of–the sitting president by lowering rates.  It would signal disapproval by raising them.

 

However, as Alan Kaplan points out, the Fed is political.  One could easily maintain that the Fed has enabled the continuing failure of Congress to enact sensible fiscal measures to support economic growth.  (The other side of the argument would likely be that although members of Congress may have cultural agendas, the ones who show up at briefings by the Fed are shockingly ignorant about basic economics.  So they have no idea of how to craft prudent fiscal stimulus.)

One other issue.  The emergency-low interest rate policy we’ve had in place for eight years places the interests of borrowers ahead of those of savers.  Another political decision.  A generation or two ago the latter would have been the ultra-wealthy.  In today’s world, savers are Baby Boomer retirees, whose ability to establish a secure stream of interest income to support their lifestyles has been diminished by government policy.

 

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