Monetary policy and presidential politics

By Jeff Huther
ABA Data Bank

In setting monetary policy, Federal Reserve policymakers often talk about the many data points they consider before deciding what to do with interest rates. The one factor they say they don't consider is politics, especially in an election year.

Just this week, Fed Chairman Jerome Powell noted at the Stanford Graduate School of Business that Fed policymakers "serve long terms that are not synchronized with election cycles," adding that "our decisions are not subject to reversal by other parts of the government, other than through legislation. This independence both enables and requires us to make our monetary policy decisions without consideration of short-term political matters."

The current Federal Open Market Committee may feel insulated from politics, but history tells us the Fed is usually reticent to make monetary policy changes in the months before presidential elections. In 2024, the Fed will need compelling evidence that interest rate changes are needed to meet its statutory goals. With inflation still above the Fed's preferred target and unemployment still low, Powell and his colleagues may not feel the need to take action.

A review of interest rate policy going back to the 1990s shows that the Fed usually remains on hold in the immediate months prior to a presidential election. Changes in the Fed's target interest rates in election years are shown in the chart below. Over the past eight presidential election cycles, the Fed has raised its target rate in three years-2000, 2004 and 2016-and lowered its target rate in 1992, 2008 and 2020. (We'll ignore the small decrease at the very beginning of 1996.) But the Fed made significant changes to interest rates in the second half of presidential election years only in 2004 and 2008.

In 2004, the Fed raised rates during the fall campaign season (the shaded area in the chart). The Fed raised its target rate 25 basis points each meeting beginning in June and may have concluded that the combination of a mechanical approach, coupled with historically low interest rates (at that time), meant that the policy tightening would not be viewed as politically motivated. Indeed, the Fed may have continued the 25 basis point-per-meeting approach well past the appropriate stage to reinforce the idea that the rate hikes were a "hands off" policy; the 25 basis point increases per meeting continued into the middle of 2006.

In 2008, the Fed faced near-unanimous calls to respond to the global financial crisis that fully erupted that September with the Lehman Brothers bankruptcy. There was even an ad hoc interest rate reduction one month before the presidential election. The crisis gave the Fed more than its usual flexibility and as a result, there was likely little concern that its actions would be perceived as being politically driven.

Coming into 2024, Fed officials have repeatedly said that their decisions are data-dependent. The data, for the Fed, are the employment numbers and the inflation numbers. Short of a large shock to the economy, the employment numbers are unlikely to be a concern this year. Inflation has been trending down, but it is still above the Fed's target.

Given the data and the Fed's history in election years, the Fed has two paths for 2024. It can hold steady on interest rates until after the election or respond to data that convincingly shows that the rate changes are purely apolitical. If it chooses the latter approach, it will need to lay the groundwork soon through speeches, press conferences and meeting minutes. The strength of recent data, however, suggests Fed policymakers may be able to stand pat until after Americans head to the polls.

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