Did the Republicans Force Bernanke’s Hand?

To what extent is the Fed responding to political pressures?  Of course, Federal Reserve officials like to believe they are above the fray, and vehemently deny that political considerations play any role in their decision-making process. They must be above the fray, otherwise the cherised independence would be broken.

I know this is what I am supposed to believe.  Doesn’t every Fed watcher?  Yet I can’t help but think that it would be naive to believe that any institution in Washington is above politics.  It is simply not that kind of town.  The degree that you have the illusion of independence depends upon your ability to have a substantial block of fiscal policymakers that believe you are doing your job.  And not “your job” as you define it, but as they define it, whether or not their definition makes any sense.  Such is Washington.

Which brings me to Pedra da Costa’s Reuters piece this morning:

Increasing political encroachment on the Federal Reserve, particularly from the Republican Party, could threaten the central bank’s hard-won independence and undermine confidence in the nearly 100-year old institution.

That was the pervasive sentiment among economists gathered at the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming. Against the dramatic backdrop of the Grand Teton mountain, many said a closely-contested presidential race has turned the monetary authority into a political football.

It has always been feared that political independence would be threatened from the left, with the ultimate result of hyperinflation.  Not so anymore:

“I do fear for it a bit if the election comes out that way, especially if some of the more radical voices, that happen to be Republican voices nowadays, get reelected,” said Alan Blinder, Princeton economics professor and a former Fed vice chairman, adding that historically opposition to the U.S. central bank had come predominately from the left.

“There’s a lot of hostility,” said Blinder, who was appointed to the Fed by former president Bill Clinton.

Of course, some believe that political pressure is already having an impact:

For some observers, that pressure is already affecting the Fed’s behavior, preventing it from pushing more aggressively for stronger economic growth following the sharp blowback received back in 2010, when policymakers announced their last large scale bond purchase program.

If in fact this is true, then Federal Reserve Chairman Ben Bernanke made a disastrous tactical error.  By not responding even more aggressively, as he now appears to be headed, he opened the Fed up to additional attacks because monetary policy looked ineffective at supporting the economy.  As they say, the best defense is a good offense.  If the economy looked to be returning to the pre-recession path of nominal GDP, the Fed’s detractors from both the left and the right would have less ammunition for criticizing monetary policymakers.

That, however, is not the world we are living in.  Instead, we are now in a world in which the ideas gaining traction within the Republican party include an audit of the Fed, the elimination of the dual mandate in favor of only an inflation target, and, incredibly, a return to a gold standard.  Moreover, even if such efforts ultimately prove fruitless, we have seen that the confirmation process for Fed governors turn increasingly political.  It would not take much to believe that a Republican-controlled Senate with Mitt Romney as President would seek to pack the Fed with clones of Dallas Federal Reserve President Richard Fischer.

In essence, the time for more monetary accommodation may be growing short.  Bernanke must assess a nontrivial possibility to a Romney Administration, the candidate who has already promised to fire the Fed chair.  Obviously, Bernanke then has no reason to forestall additional easing in hopes of retaining his job in a Romney Administration.  Bernanke must also assess a nontrivial possibility to the odds that political pressure on the Fed only increases, and that pressure will continue to come from the right.  If such events do unfold, odds are policy will turn tighter earlier than it should, with what he likely believes would be disastrous consequences to the economy.

In other words, if the Federal Reserve is to deliver more easing, it needs to be sooner than later.  It will only become harder in the days ahead.

Bottom Line:  Based on the current mode in Washington, it is difficult to believe that political pressure from the right on the Federal Reserve does anything but intensify.  Interestingly, to the extent that the Fed is not immune to political pressure, one could argue we are at a point where such pressure induces the Fed to do more, not less.  Rather than resisting taking more action because he fears the political consequences, Bernanke might look into the future and conclude he can wait no longer as Congress is unlikely to react to his calls for fiscal help while the “hard money” crowd continues to make gains within the Republican party.  While I think the state of the economy should have forced the Fed’s hand long before now, the possibility that they might only get one more bite at the apple should be extra inducement to act.

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