Presidential Elections and Federal Reserve Policy: An Empirical Test

Abstract

Traditional macro-economic models of Federal Reserve (Fed) behavior typically assume that the Fed enjoys a well defined objective function based on social welfare, and generally predict counter-cyclical monetary policy. The increasing observation of procyclical monetary policy has led many researchers to investigate new models of Fed behavior. Several recent papers imply that procyclical Fed behavior is due to a lack of political accountability. Friedman [7], Toma [23] and Shughart and Tollison [21] all attribute considerable bureaucratic discretion to the Fed and seek to explain monetary policy by examining typical bureaucratic objectives.' Other papers, such as Pierce [19; 20], Weintraub [26] and Kane [10; 11] argue that the Fed operates in an arena filled with political constraints that cause sub-optimal monetary policy, but these constraints are not modeled explicitly. One possible political constraint on Fed behavior is the incumbent president's desire for re-election. In the Political Business Cycle (PBC) literature, presidential re-election opportunities are enhanced by the production of a precise set of inflation and unemployment outcomes leading up to the election. Thus, to the extent that presidents desire cyclical macro-economic outcomes, there will be Executive pressure on the Fed to create or accommodate such outcomes. The effect this pressure will have on Fed policy is ultimately an empirical question, but most models deal with it by assumption. Traditional macro modeling assumes a zero effect, while the PBC models implicitly assume that a favorable election cycle is a primary goal of all economic policymakers. This paper examines presidential influence on the Federal Reserve by testing for an election cycle in money growth. The major result is the identification of a regular 16 quarter cycle in money growth corresponding with presidential elections. This cyclical effect is found to be stable over time and significant under a wide range of model specifications. Further, when the cyclical component of money growth is used to simulate a simple macro model, it produces a classic political business cycle in inflation and real output growth.