“Just kick their ass a little bit,” the president told the chairman of the Federal Reserve four days before the central bank’s interest rate-setting committee met. The American economy was limping, federal spending was a growing concern, and war was raging halfway around the world.
It was late 1971, and President Richard Nixon was on the phone with Fed Chairman Arthur Burns. Burns told the president that the Federal Open Market Committee was going to cut the key interest rate in an attempt to stimulate the economy. Nixon wanted Burns to send a clear message that the committee must act aggressively to ease monetary policy. The 1972 presidential election was 11 months away.
It took a decade marked by demoralizing inflation and soaring unemployment before the Federal Reserve began to establish its reputation as a policy-independent institution.
Fifty years later, the Fed’s reputation has been tarnished not by the overt political ambitions of a ruthless and lying president, but rather by his own misjudgments about monetary policy. And fighting these misconceptions undoubtedly has a political cost.
Keep all of this in mind next week as the Fed holds another interest rate meeting and Americans continue to vote early in the midterm elections. Inflation will be the defining issue for both.
Investment markets are convinced that the bank will continue the pace of raising interest rates, raising the key lending rate by another three-quarters of a percentage point. Doing so a week before the election is an important indication of the Fed’s independence from political influence, unlike 50 years ago. The agency is expected to show its patience by reducing that pace in the coming months. That expectation has helped the share price gain ground over the past two weeks.
Voters may not be patient enough to feel the effects of efforts to fight inflation. Republicans would prefer to regain slim control of the House of Representatives, while the majority in the Senate may still rest on the vice president’s casting vote. Each party blames the other for today’s inflation, with little serious talk about how to solve it sensibly, because it is much harder for politicians to make such decisions.
For Congress, fighting inflation means slowing the growth of government spending. Making choices about what to spend less on will be difficult because of a divided government and a divisive election two years from now. For the central bank, fighting inflation means higher interest rates and the risk of recession.
Investors should watch for efforts to use monetary policy as a weapon for political convenience. This is a matter of economic confidence.
Tom Hudson is a financial journalist and director of content at WAMU Public Radio in Washington, DC. Follow him on Twitter @HudsonsView.