How elections test the Federal Reserve interest rate cycle

How elections test the Federal Reserve interest rate cycle

The anticipated November matchup between President Joe Biden and former President Donald Trump could come down to voters’ views on the economy.

Inflation is among the biggest problems in the country, according to a May 13-19 Pew Resarch Center survey of U.S. adults. The rising prices may influence voters’ views of Biden.

Annual inflation as measured by the consumer price index, or CPI, peaked at 9.1% in June 2022 and has since cooled to around 3.3% in May 2024. Annual inflation as measured by the personal consumption expenditures, or PCE, index stood at 2.7% in April 2024, according to the Bureau of Economic Analysis.

Some experts say modern era inflation in the U.S. came about after the government approved measures to stimulate the economy amid supply chain breakdowns and the onset of wars around the world.

“Most of the fiscal stimulus occurred when President Trump was president. President Biden continued that with another round,” said David Kelly, chief global strategist at J.P. Morgan. “Inflation works with a lag. And so this was built up all the way through the pandemic.”

Why some presidents want to intervene in Federal Reserve activities

Central banks including the Federal Reserve are tasked with setting interest rates to stabilize prices. But political leaders have an incentive to intervene in short-term rate-setting, which can influence their chances at the polls.

In April 2024, The Wall Street Journal reported that Trump’s advisors would seek a greater role in the future trajectory of interest rates.

“You would have an arrangement with the Fed that is not the norm we’ve had for the past 40 years,” said Nick Timiraos, chief economics correspondent for The Wall Street Journal.

The reporting evoked memories of a volatile period in U.S. politics and economics. In the lead-up to the 1972 election, President Richard Nixon directed then-Fed Chairman Arthur Burns to issue stimulative interest rates, hoping it would help him secure his electoral victory.

“All of that monetary easing led to this big burst of inflation,” said Carola Binder, an associate professor of economics at Haverford College.

While today’s economic situation is far from the stagflation of the 1970s and ’80s, an erosion of Fed independence could set the country down an unsettling path.

How economic decisions are made at the Fed

Seven of the 12 voting members of the Federal Open Market Committee are nominated and confirmed by politicians. The remaining five are presidents of the Federal Reserve banks, which represent different regions and business interests scattered across the country.

“This regionalism is really a nod to our federalist system of government itself,” said Christina Parajon Skinner, an assistant professor of legal studies and business ethics at the University of Pennsylvania’s Wharton School of Business.

The committee meets eight times a year to increase, hold or decrease the overnight lending rate that is charged for banks to shore up their mandatory reserve balances.

“Those rates, in turn, tend to be very, very closely mirrored in the financial markets. And those are the rates that consumers experience,” said Skinner.

The Fed’s post-pandemic balancing act

From 2022 to 2023, the FOMC increased its federal funds rate from a target range of around zero percent to a range targeted between 5.25%-5.5%. In the process, the financing terms for consumer goods such as homes and cars have become more expensive.

The higher cost of borrowing is intended to slow demand from consumers, thereby cooling off price increases, in theory.

“Demand has clearly come down a lot over the past few years,” said Fed Chair Jerome Powell at the May 2024 meeting.

Higher interest rates can also limit the government’s ability to pay back its debts.

“I think future presidents, and perhaps also Congress in the future, might be tempted to not get the fiscal house in order and instead pressure the Fed to do the job,” said Thomas Drechsel, an assistant professor of economics at the University of Maryland.

Both presidential campaigns declined CNBC’s request for comment in time for publication.

Watch the video above to learn more about how Fed decisions can influence election outcomes.

Original news source Credit: www.cnbc.com

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