Is There Bias at the Fed?

Rick Perry’s recent reflections/threats regarding quantitative easing have occasioned some speculation about whether his raising the political profile of the issue might actually affect Fed behavior; making the Fed less willing to engage in a third round of easing.  The question of political bias at the Fed has been raised before, here in this Levy Institute working paper (free of any implicit promises of lynching) authored by Galbraith, Giovannoni, and Russo.  The authors reveal that there is in fact an argument to be made for the existence of partisan bias, at least for the period 1984- 2003:

…we find that in the year before presidential elections, the term structure [of interest rates] deviates sharply from otherwise-normal values. When a Republican administration is in office, the term structure in the preelection year tends to be steeper, by values estimated at up to 150 basis points, and monetary policy is accordingly more permissive. When a Democratic administration is in office, the term structure tends to be flatter, by values also estimated at up to 150 basis points, and monetary policy is more restrictive. These findings are robust across model specifications and across time, though the anti-Democrat effect is smaller after 1983. Taken together, they suggest the presence of a serious partisan bias, at the heart of the Federal Reserve’s policymaking process.

Now, perhaps this trend has reversed itself, for some reason, under the leadership of Republican-appointed Ben Bernanke.  But determining whether or not the current Fed has been “playing politics” lately, as Perry alleges, is not as obvious as he might suggest.  Put aside whether we’re able to draw a clear line between how Fed policy affects economic performance and the political motivations of the FOMC.  Before we get to that part of the story, it’s not at all clear that the Fed has been doing all it can to improve the growth and employment situation (presumably the factors that Perry thinks would aid in Obama’s re-election).

On the one hand, the Fed could certainly be doing more to make growth and unemployment worse.  They could have refrained from committing to keep rates low for two years (as at least three dissenting members on the FOMC would have preferred)—or they could raise rates immediately.  But despite the measures taken by the Fed over the last few years, it is arguable that monetary policy is actually relatively tight at the moment, and has been throughout the recession and non-recovery.  As Ramesh Ponnuru, senior editor at the well-known leftist rag National Review, argues:  “Conservatives are suspicious of any loosening because they think of it as a government intervention in the free market. But they are wrong. A central bank that keeps the supply of money too low is just as interventionist as one that keeps it too high.”

At any rate, although the implicit threat of violence in Perry’s comments seems to have drawn most of the attention, his statement is also remarkable in that it suggests a relative open-mindedness on his part with respect to at least the empirical question of unorthodox monetary policy—he seems willing to endorse the view that quantitative easing would actually improve the economy in the short-term.