Tuesday, September 18, 2012

Puppetmaster or Scapegoat?

It's all been done before and it will continue evermore;
 almost every single election since its inception;
 the Federal Reserve will have the nerve;
 to be the mind's eye of monetary supply.

Ben Bernanke has had the world's greatest minds come together to confirm that I should not be a poet. 

The Federal Reserve, headed by the guy in the picture above, serves as the central bank of the United States. All of the members of the Federal Reserve committee determines if they need to print more money or un-print more money (whatever the opposite of printing money is) in order to fulfill the dual mandate of controlling inflation and minimizing unemployment. The Federal Reserve has set unofficial targets of keeping inflation at 2 percent and unemployment under 5 percent. After looking at all the latest and greatest data on the economy, the board has determined that inflation is too low, unemployment is too high, and that the economy is not going to fix itself any time soon; therefore they decided to launch another Quantitative Easing (QE3) program. The 3 is because it is the third time of the current recession that they have undertaken such a policy. 

Republicans are against it. Democrats are for it. Both for the same reason. It's going to boost the economy right before the election, which will help the incumbent and hurt the challenger. But how much difference it will actually make is not clear.

It's not the first time this has happened. To be honest, the Federal Reserve has taken some course correction every election cycle for the last 60 years. Twelve of the last 15 cycles, the Federal Reserve engaged in monetary easing. The other three were monetary contractions. It has not always benefited the incumbent, either. This is what an independent Central Bank does. They ignore the the election and do what the economy needs to be done. This story would not be complete without talking about Paul Volcker.

No one throws a recession party like Paul Volcker throws a recession party. 

Jimmy Carter appointed Paul Volcker as the Chairman of the Federal Reserve in 1979 because he had a plan to stop the (almost) runaway inflation that has hampered the economy since the 1973. Double digit inflation had taken its toll for six long years now. A dollar was worth less than half of what it was worth before the oil embargo.Volcker was going to raise interest rates, which would cut the monetary supply, to get inflation under control. Only problem is that it would cause a recession in the process. Jimmy Carter made no attempt to influence Volcker's decision to cut the power to the economy. The lights went out. Growth grounded to a halt. Inflation receded. Carter lost re-election. Reagan became President. The economy bounced back, inflation-free, in 1982. 

Now that is not a typical situation. Let's take 1992 instead. The economy went into a recession by itself. President Bush the Elder asked Federal Reserve Chairman Alan Greenspan to take action. After looking at economic data for a few months, Greenspan's and his Board of Governors cut interest rates - which expanded the monetary base, but was far less than what the President wanted. It was too little too late. Bush lost the election to Clinton. “I reappointed him and he disappointed me,” Mr. Bush said.

Would have a more forceful and quicker action made the difference for Mr. Bush? Will bond buying by the Federal Reserve change the outcome for Mr. Obama today? On both instances, probably not. Will the one party or the other accuse the Central Bank of screwing them either way? Probably so. There is no question that monetary policy can help the economy in the long-run, but there is also no evidence that it in itself has enough power to change the outcome of elections. 

It may be because it will take about six months before people are going to feel the impact of this policy; Making it hard to fix an election that is two months away.

In your opinion, is the Federal Reserve Chairman a Puppetmaster or a Scapegoat to the election? Or neither?

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