The Fed is meant to be independent and free from political pressures emanating from Congress or the White House.
That hasn’t always been the case.
For instance, back in the early 70s, Fed Chairman Arthur Burns was pressured by Richard Nixon to manipulate interest rates to suit the political cycle.
Today, the Fed is probably as free as it ever has been from direct political manipulation. However, the November elections could still play a role in monetary policy: the Fed may feel an implicit pressure to maintain the status quo for fear of being used, or abused, by politicians searching for votes.
Given the previous political controversies over quantitative easing, the program to create money and buy bonds, it’s probable the Fed may feel unwilling to embark on a third round, even if it thought that this was necessary. That said, such an outcome looks unlikely at present, particularly in light of minutes from the FOMC’s April 24-25 meeting, published last week, that spoke of a more positive future for the economy. We should assume that more easing isn’t on the agenda.
Perhaps of more relevance is the growing view that it’s time to start tightening monetary policy. European concerns aside, a combination of higher consumer prices, easing conditions in credit markets, and possibly bottoming-out house prices all point in the direction of policy tightening. Sheila Bair, former chair of the FDIC, argued last week in the context of the JPMorgan trading loss that low rates are forcing banks to search for yield, which raises systemic risks in the financial system.
The job of setting monetary policy requires a crystal ball, something that no one has. There’s always a risk that the Fed acts too soon and dampens the recovery. The election, no doubt, will play on policy-setters’ minds. Subconsciously, FOMC members may prefer to avoid raising rates and being brought into the political debate. The result may be higher inflation and higher interest rates in the future.