Playing Politics with the Federal Funds Rate

If things go as expected, on Wednesday Federal Reserve Chairwoman Janet Yellen will announce the first Fed rate hike in almost a decade (2006 was the last time the Fed increased the federal funds target rate).

Since 2006, we’ve seen a peak in the housing market, a collapse in global financial assets, unemployment above 8%, and the weakest recovery in modern record.

Over this period, the Federal Reserve hasn’t sat by as an idle observer.  Under Ben Bernanke’s and Janet Yellen’s leadership, the Federal Reserve transformed itself into master manipulator, not only lowering the federal funds target rate to virtually 0% for an amazing 7 years, but also accumulating about $4.5 trillion in assets (up from the $800 billion in assets it had before the onset of the global financial crisis).

Many observers – economists among them – have openly wondered about the political cycle baked into the Fed’s actions.

Is the pending Fed rate hike due to concerns about inflation?  Is the Fed concerned about financial asset bubbles ?  Is the Fed concerned about a potential recession on the horizon with nowhere to move the federal funds target rate if it doesn’t start hiking soon? Is the Fed really raising the target rate to avoid political suspicions?

Without delving into the many potential reasons affecting Ms. Yellen’s intentions, here’s a refreshed look at the latter question.

The Fed Funds Rate Cycle by Party

First, a variation on a chart we’ve shown before.  It is the federal funds target rate by U.S. president, with each color representing a given U.S. president. The broader business and inflation cycle is readily transparent. The federal funds rate generally increased from the 1950s to the early 1980s.  Since then, a downward long-term drift is clearly present.

Now here’s a look by party.  See any political preference?

Visually, it doesn’t look like there’s anything there, but, of course, we’re only looking at one variable.  A more reasonable inspection is to look at job growth and the inflation rate in conjunction with the federal funds rate.

A Look at the Fed Rate According to a Forked-Taylor Rule

Perhaps the most famous monetary policy idea is the Taylor rule, which simply states that the federal funds rate can be generally predicted by the inflation rate, the target inflation rate, output, and the target output figure.  If an estimate of the Taylor rule shows any political bias, then there’s probably something to the findings.

Here’s a look at the average of the difference between the Taylor rule federal funds target rate and the actual federal funds target rate by U.S. president. Fascinatingly, the sitting president has gotten the most charity from the Fed, with an amazing 4% help from the Fed during his tenure.

Next in line is Eisenhower, followed by W. Bush, Kennedy, and Johnson. On the other end, the Fed had little love for Reagan and Bush I, keeping the target rate much higher than what the Taylor rule would predict.

Interesting.  Perhaps Republicans are on to something.  The Fed might not be as nonpartisan as it purports to be.

Conclusion

In looking at the federal funds rate by U.S. president, it’s interesting to note the political cycle of the Fed’s famous interest rate. When adjusting the federal funds rate for the state of inflation and job growth, the Fed appears to have a (small) preference for Democratic administrations. Perhaps it would do Republicans some good not to criticize the Fed so often.