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Economists challenge Fed independence

Burton A. Abrams, professor of economics
10:16 a.m., March 28, 2006--It has long been believed that the Federal Reserve System, the organization responsible for setting U.S. monetary policy, is insulated from political pressures. University of Delaware economists Burton A. Abrams, professor of economics, and Plamen Iossifov, who recently earned a doctorate in economics from UD, find evidence to the contrary in an article to be published in the academic journal Public Choice.

“We find evidence that the Fed sets an unusually aggressive monetary policy in the run up to presidential elections when the Fed chair and the president have a political affiliation,” Abrams said, “and that this relationship holds, on average, for both Republicans and Democrats.”

Abrams and Iossifov evaluate the Fed's monetary policy actions for the period 1957-2004 by assessing its usual response to various economic conditions.

“The Fed seems to target its primary interest rate, the federal funds rate, quite predictably in response to inflation and unemployment considerations until a presidential election looms and the Fed chair and the sitting president have a party connection,” Abrams said. “At that point, the Fed seems to err on the side of over-stimulating the economy by targeting the federal funds rate lower than circumstances would suggest.”

Economists and political scientists have previously established a link between favorable employment news and subsequent votes for the sitting president or the sitting president's party. This link provides a political motivation for presidents to pressure the Fed and for Fed chairs with partisan affiliations to over-stimulate the economy in the run up to the election, Abrams said.

Abrams and Iossifov find that, if there is no political party connection between the Fed chair and the president, the Fed abstains from over-stimulating the economy.

Abrams and Iossifov also find that Alan Greenspan, the recently replaced chairman of the Federal Reserve, had performed significantly less politically than his predecessors. “It seems that a strong or independent Fed chair may be able to resist the temptation to act politically, but this is the exception not the rule,” Abrams said.

Abrams said the findings of a politicization of Fed policy and the recent appointment of Ben Bernanke as chairman can be expected to reinvigorate debate concerning the desirability of imposing explicit rules on monetary policy actions.

Article by Neil Thomas
Photo by Kevin Quinlan

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