Common assumptions about how the Fed affects elections are not necessarily correct, however. Lee's piece was part of a lively debate about the Fed and elections following a Dec. 29 Wall Street Journal op-ed by Mickey Levy. He compared the fed funds rate in November of presidential election years with what it had been in December of the previous year. Levy concluded that monetary policy has not been influenced by election year politics, except in 1972, when Fed Chairman Arthur Burns allegedly eased it to help re-elect Nixon.
Levy was challenged by two economists at the Institute for International Economics, Gary Hufbauer and Paul Grieco. They focused on the six months from May to October during election years and found fewer interest rate changes during those "critical" months. They also found that rates were more often pushed lower than higher during those months. This suggested an election-year bias toward ease. Yet neither Levy's December to November period nor his critics' May to October period really captures what was going on and how it related to elections.
The common idea that elections prevent the Fed from doing anything, to avoid looking political, is not based on any facts. In 1980, the funds rate was slashed from 17.6 percent in April to 9 percent in July, before being quickly increased to19 percent in December. Not exactly unchanged. In the nine election years since 1960, the Fed left interest rates roughly unchanged only twice, in 1976 and 1996.
The Fed eased three times, in 1960, 1972 and 1992, yet the incumbent party lost two of those three. The Fed tightened four times, if you count the 1980 roller coaster, but the incumbent dropped out in one of those (1968). In the two clearest cases of the fed funds moving significantly higher, 1984 and 1988, the incumbent party easily kept the presidency both times.
In 1960, the fed funds rate fell from 3.9 percent in May to 2.4 percent in November. But Republicans lost the White House because the economy was in recession and Eisenhower promised to keep tax rates sky high in the hope of running a budget surplus. This was a prime example of election-year easing during Hufbauer and Grieco's "critical months," but it was scarcely well-timed to help Nixon beat JFK.
1992 was another case of supposedly political easing, as defined by Hufbauer and Grieco. Yet George Bush Sr. lost that election partly because he had raised tax rates in the middle of the recession of 1990-91, but also because the Fed was extraordinarily slow to ease interest rates. The fed funds rate was still 6.1 percent in March 2001, when the recession ended. It was then only very gradually reduced to 3.1 percent by November 2002. The Fed wasn't ardently fighting the 1990 recession until 1993 -- a case of too much too late.
The Fed raised the funds rate from 9.5 percent in December 1983 to 11.6 percent in August 1984, for no apparent reason except that the economy was doing very well. So what? Reagan easily won re-election by a huge margin.
From December 1987 to November 1988, the funds rate was again increased from 6.7 percent to 8.4 percent. That certainly did not keep former Vice President Bush from becoming president.
In short, incumbent presidents usually do better when the Fed is pushing rates up than when it is pushing rates down, unless high inflation is involved (1980). This is not as paradoxical as it may sound. Falling interest rates are usually a sign of economic distress, while a reasonable rise in interest rates is a routine side effect of a vigorous economic rebound.
It makes neither economic nor political sense to sell stocks cheap out of fear that the lowest interest rates in modern history are sure to move a bit higher, sooner or later. When the herd sells good stocks for bad reasons, I buy.