The Federal Reserve May Be Politically ... - Pluto Huji Ac Il

the fed may be politically independent,
but it is not politically indifferent
William Roberts Clark ∗
Vincent Arel-Bundock †
June 6, 2011
Before the advent of positive political economy and public choice economics,
text-book macroeconomic models assumed policy was controlled by benevolent planners
seeking to maximize social welfare (e.g. full employment, economic growth
and price stability). Over the last few decades, however, the aforementioned schools
have chipped away at the idea that the self-interested actors that inhabit our models
of rms and households magically become social welfare maximizing saints when
they enter public service. Positive political economy models have typically replaced
benevolent social planners with survival or vote maximizing politicians. ese politicians
may have policy goals, but they must weigh these goals against the fact that retaining
office is oen a necessary condition for them to even achieve their objectives.
e positive political economy of monetary policy, however, represents a partial
exception to this trend. Analyses of the time inconsistency problem in monetary policy,
for example, retain benevolent social planners to demonstrate the robustness of
the problem: discretionary policy leads to higher than optimal ination rates even if
we are fortunate enough to have an economy run by benevolent social planners (Kydland
and Prescott (1977), Barro and Gordon (1983)). Elected politicians are thought
to be particularly sensitive to the political pressures that ensue when output falls below
the natural rate. ey are, therefore, keen to trade increased ination for output
gains. is generates a time inconsistency problem - if politicians could commit to a
low ination rule, they would be able to produce an outcome closer to the social optimum,
but short-term political pressures, perhaps induced by the electoral calendar,
make such commitments incredible.
∗ Professor of political science, University of Michigan
† PhD student, Department of political science, University of Michigan
1

One solution (Rogoff, 1985) is to appoint a central banker whose preferences over
ination are sufficiently hawkish to produce, somewhat unwittingly, a socially desirable
outcome aer it too falls victim to the time inconsistency problem. Another
(Walsh, 1995) is to write a contract between the political principal and the central
banker that ties the banker’s compensation to its ability to meet predetermined policy
goals. 1 In the Rogoff model, elected officials who delegate to a conservative central
bankers are essentially strategic benevolent social planners. Like Odysseus, they tie
themselves to the mast and resign their fates to slaves with wax in their ears in order
to accomplish what they could not achieve on their own - the optimization of a social
welfare function. In the Walsh model, elected politicians with the song of sirens in
their ears nevertheless enshrine the actions of the benevolent social planner in the
optimal contract they sign with a central banker who is a sufficiently good wage slave
to do what he or she is told.
Canonical models of central bank independence, then, take one step forward and
one step back. ey treat politicians as electorally-minded strategic actors capable of
designing institutions that trick central bankers into producing policies preferred by
the median voter. But they assume that central bankers are apartisan technocrats who
optimize within the constraints created by their political principals without considering
how the choices they make today can shape the political environment tomorrow.
In this paper, we consider what happens when the positive political economy approach
is applied more fully to the political economy of central bank independence.
What if both the elected principal and the central banker look and act like the individuals
in our models of rms and households? Our answer is that strategic, conservative
central bankers should behave as conditional ination hawks. ey should be less responsive
to inationary pressures when the incumbent politicians have preferences
similar to their own.
We analyze data on half a century of Fed policy to evaluate our argument. We
nd that the Fed raises interest rates as elections approach when Democrats control
the White House, but lowers interest rates as elections approach under Republican
administrations. Furthermore, when Democrats control the White House, the Fed
lowers interest rates in response to increased inationary expectations, especially as
elections approach, but it is insensitive to the gap between actual and potential output.
In stark contrast, when Republicans are in office, the Fed lowers interest rates
as the economy enters a recessionary period- especially as elections approach - and
is insensitive to inationary expectations. ese results are consistent with the idea
that the Fed prefers Republican presidents, and that it acts to help ensure their election
and re-election. Anecdotal evidence suggests that the political independence of
1 ough it is not clear to us why the principal’s threat to punish the agent for behaving as it would
behave are credible.
2

the Fed allows it to act effectively in light of its political preferences: Republicans were
much more effective in gaining and keeping the White House in the half-century aer
the Fed became operationally independent than in the period preceding operational
independence.
In the next section we explain why the Fed could prefer that the White House be
controlled by Republicans, and we discuss why this should lead it to act like a conditional
ination hawk. In section 2 we present evidence that the Fed Funds Rate (FFR)
is tied to the electoral calendar and that that this link is different when Republicans
control the White House and when Democrats do. In section 3 we present evidence
that the Fed’s reaction to ination and the output gap depends on both the election
calendar and the partisan orientation of the White House. Section 4 summarizes our
results and describes changes in the presidential electoral fortunes of the two parties
during the (near) century since the creation of the Fed.
1 why the fed is a conditional inflation hawk
We argue that the Fed manipulates monetary policy in a partisan fashion. In this
section we articulate two steps of our argument. First, we explain why the Fed cares
which party rules. Second, we show why this leads the Fed to respond to electoral
and macroeconomic pressures in a manner that is conditioned by the party of the
president.
1.1 If Parties Have Monetary Preferences, Conservative Central Bankers Have
Partisan Preferences
e standard partisan model of monetary policy assumes that political parties represent
constituencies with distinct preferences over ination and unemployment (cites).
One way to think of this is that net debtors are less concerned with ination than net
creditors and, so, place a greater weight on achieving their output goals than their
ination goal. Even if both actors had the same output goal, the amount of ination
they would be willing to tolerate to accomplish that goal would differ. For example,
imagine citizen i ′ s policy preferences were given by the loss function:
Li = α(π − π ∗ ) 2 + (1 − α)(y − y ∗ ) 2
where y is output, y ∗ is i’s output target (perhaps potential GDP) , π is ination and π ∗
is i ′ s ination target. Assume, without the loss of generality, that all citizens in society
share target rates for output and ination (perhaps potential GDP and zero ination).
Individuals would still differ in their assessment of outcomes if they placed different
weights on hitting these targets. Individuals with α < .5 care more about hitting
3

Figure 1: Spatial relationship between central bankers and parties
L R CB
0 1
Weight on ination
their output target than hitting their ination target, and vice versa for individuals
with α > .5. Holding ination constant, actors can be arrayed along a unit interval
from α = 0 (output junkies) to α = 1 (ination hawks). e partisan model of
monetary policy assumes that le wing parties represent the interests of voters with
lower incomes who care more about output than ination, placing them on the lower
end of this unit interval. Right wing parties are thought to represent high income
individuals who care more about ination than output, placing them on the upper
end of this unit interval. e desire to represent the interests of voters in their natural
constituency induces ideal points for le and right-wing parties as pictured in Figure
1.
e Rogoff model of central bank independence maintains that the time inconsistency
problem in monetary policy can be overcome if politicians delegate policy to
a central banker who is even more ination adverse than right wing politicians. us
central bankers will have alpha’s that place them to the right of right wing parties as
in gure 1.
ere are reasons to believe, however, that even independent central bankers will
not be able to implement their ideal point. McCubbins and Schwartz (1984) argue
that executive agencies granted with autonomy need to be mindful of the fact that
the legislature that grants that independence can also take it away. Helge Berger and
Friedrich Schneider (2000) showed that the Bundesbank’s policies moved in parallel
with changes in the composition of the Bundestag. Keefer and Stasavage (2003)
would predict this sort of sensitivity to changes in the composition of the body since a
change in the composition of government is likely to lead to a change in the reversion
point - the policy that the government would implement in the absence of independence
- should the implicit bargain between the government and the central bank fail.
A rational central banker will seek to deter the government’s abrogation of the agreement
that led to his or her independence and will, therefore, adopt a policy that is as
close to its ideal point as possible, subject to the constraint that the political coalition
needed to abrogate independence needs to be at least indifferent between the policy
adopted by an independent central bank and the policy that would prevail in the ab-
4

sence of independence. e exact position adopted by an independent central banker
will, therefore, be inuenced by the political institutions that dictate what is necessary
to change the status quo - including, executive legislative relations, the presence of a
second house, super majority requirements, and whether the government is a coalition
or single party government. But, in general, if the central banker’s ideal point
is to the right of the right most party, the best it can do in the short run is move to
the le when the a le wing party comes to power and to the right when a right wing
party comes to power. At the very least, we can expect policy to be somewhere in
the interval beween R and CB when there is a right-wing government in power and
L and CB when there is a le wing government in power (see Figure 1). If central
banks are (at most) partially independent, then we can think of equilibrium policy as
being some convex combination (determined by the degree of independence) of the
ideal points of the government and the the central bank Franzese (1999). While, for
all the reasons just stated, it is difficult to predict exactly where the optimal short run
policy is for the central banker none of the above qualications challenge the notion
that to the extent that the central bank is independent, we can expect policy to be
somewhere between the government’s ideal point and the bank’s ideal point and this
location should be closer to the central bank’s ideal point when a right wing government
is in power.
1.2 Central Bankers with Partisan Preferences Have Incentives to Try to In-
uence Elections
So far our discussion suggests that we ought to observe uctuations in interest rates
in the United States that are consistent with the traditional partisan model. e Fed
should guard its independence by accommodating le wing policies as the political
center of gravity moves to the le, and it is free to adopt a policy closer to its ideal
point as the center of gravity moves to the right. An alternative model, the political
business cycle model, presumes that politicians are responding to a homogenous
electorate that votes in a myopically retrospective fashion - they vote for incumbents
that produce short-term macroeconomic expansions just before elections, and vote
for challengers when no expansion occurs (cites to economic voting lit? up to and
including Duch and Stevenson). Alpanda and Honig (2009), Clark et al. (1998) and
Clark and Hallerberg (2000) argue that central bank independence ought to inhibit
politician’s ability to engage in this sort of opportunistic behavior, though Alpanda
and Honig nd more evidence for this constraining effect of central bank independence
in developing countries than they do in developed countries.
However, if central bankers are aware of the fact that parties of both stripes will
be under some pressure to engage in pre-electoral expansions and that voters will
reward them for doing so, they may have incentives both to help right-wing parties
5

engage in such expansion and to frustrate attempts by le-wing parties to do so. In
effect, central bankers in such a world face an inter-temporal trade-off when rightwing
government are in power. ey can push for the policy closest to their ideal
point in the feasible set knowing that doing so decreases the likelihood that the rightwing
party gets re-elected, or they can accept a more expansionary policy now in
exchange for an increase in the probability that the government in power during nonelectoral
times will be closer to its ideal point. 2 In contrast, when le-wing parties are
in power, a conservative central banker faces no such dilemma. Political preferences
align with the Fed’s well publicized commitment to price stability since the political
consequence of following through on that commitment is an increase in the probability
that a government with an ideal point closer to its own will get elected. us,
we can expect independent central banks to act like conservative independent central
banks - but only when le-wing governments are in power. When the party(ies)
the central bank favors are in power, the central bank should be more willing to accommodate
pre-electoral expansions, that is, it should act in the fashion traditionally
associated with dependent central banks. It is important to note, however, that this
conditional accommodation is not evidence of a lack of independence. Far from it.
It is evidence that the bank is using its independence to act on the fact that it is not
indifferent.
1.3 Caveats
So far we have assumed that independent central bankers have conservative preferences
over monetary policy, but we have not explained why they would hold such
preferences. We can invoke three reasons to justify this assumption. First, according
to the logic of the Rogoff model, central bank independence is created in order
to overcome the time inconsistency problem that plagues monetary policy. If those
who grant independence to the bank do so for this reason, it would not make sense
to appoint anyone other than an ination hawk. Some might nd it anachronistic to
attribute this chain of reasoning to political principals operating decades before Kydland
and Prescott, Barro and Gordon, and Rogoff, but there are other reasons why
central bankers might be conservative. Monetary policy is a technical endeavor and
exercising effective leadership of a central bank without a solid command of the economics
of nancial markets is highly unlikely. us, central bankers are likely to be
2 Another interpretation of the situation is that right-wing parties become “as if l” they were a lewing
party as elections approach and central banks are merely responding to a new ”reversion” point -
the point that the right wing government is implicitly threatening to implement if the central bank does
not accommodate their temporarily expansionary wishes. But if this was what was going on, the central
bank should also become more expansionary when elections draw near when le wing parties control
the government.
6

drawn from an epistemic community with close ties to nancial rms. In other words,
central banks are prone to “industry capture.” If one accepts Posen (1995) argument
that members of the nancial community have reasons to have anti-inationary preferences,
the selection process of central bankers makes it likely that they will be “conservative”
in the Rogoffian sense. Finally, while Adolph (2005) is careful to point out
that “independent” need not mean “conservative” he argues that central bankers may
adopt ideological positions that will be favored by future employers. If the future employment
possibilities for central bankers come overwhelmingly from nancial rms,
Adolph (combined with the Posen thesis) provides a forward-looking rationale for
central bank conservatism.
Another possible objection is that while “le” and “right” wing may be appropriate
labels for comparing socialist and business-oriented parties in western Europe,
when viewed in a comparative context, Republicans and Democrats are best thought
of as relatively similar “center-right” parties. is may be true, but all that is necessary
for our model is that the parties differ in their propensity to represent antiinationary
constituencies. Our expectations are driven by the ordinal ranking of
expected policies in the mind of the central bank, not the magnitude of the difference.
Yet another concern may be justiably raised about the impact of divided government.
Fiscal policy, for example, is driven by congress as well as the president and,
unlike parliamentary systems in Europe, when there is a partisan change in head of
government in the U.S. it does not mean that partisan control of government has necessarily
changed. In other words, maybe the Fed cares as much about who controls
congress as it cares about who controls the White House. And if that is true, ought
we not be as concerned about the Congressional electoral calendar as the Presidential.
ese are valid concerns but will, for the moment, be treated as plans for future
extension.
2 the conditional link between the electoral calendar
and the fed funds rate
e traditional political business cycle argument implies that if monetary policy is
under the sway of politicians, interest rates ought to be lowered as elections draw
near (solid lines in Panel (a) of Figure 2). Existing attempts to add central bank independence
to this picture suggest that independence ought to dampen this effect
- there should be little or no link between interest rates and the electoral calendar
(dashed lines in Panel (a) of Figure 2). e traditional partisan model of monetary
policy predicts that interest rates ought to be higher when right-wing governments
are in power than when le-wing government are in power (solid lines in Panel (b)
7

Figure 2: Hypothesized link between interest rates and the electoral calendar
Interest
rate
Republican
Democrat
CBI
No CBI
Electoralist Partisan
Election proximity
Strategic central banker
(a) (b) (c)
of Figure 2). If the central bank is a neutral ination hawk, then partisan differences
in interests ought to remain, though at a lower rate reecting the unconditional in-
uence of an independent central bank (dashed lines in Panel (b) of Figure 2). Our
model, however, predicts a relationship between the electoral calendar and interest
rates under central bank independence that is distinct from both of these alternatives.
If the central bank is actively engaged in supporting the electoral and re-electoral efforts
of right-wing parties interest rates ought to decrease as elections draw near, if
right-wing parties control the government, but when le-wing parties are in power
interest rates may be seen to increase as elections draw near (dashed lines in Panel
(c) of Figure 2 ). In contrast, in the absence of central bank independence, our model
predicts the same behavior as the traditional PBC model does (solid lines in Panel
(c) Figure 2). In this section, we use data on the Federal Funds Rate to evaluate this
claim.
Figure 3 plots the evolution of the Federal Funds Rate (FFR) against the electoral
cycle across all presidential administrations since Eisenhower’s rst term in office. 3
e difference between the Democrat and the Republican plots is striking. For every
Democratic term in office, the interest rate path ends at a higher level than it started.
For every Republican president’s term, it ends at a lower rate than it started. Figure 4
tells the same story. e Federal funds rate climbs during each Democratic administration
and falls, oen precipitously, before Republican incumbents come up for
3 Data on the FFR were obtained from the FRED database, published by the St.Louis Fed.
8

Federal Funds Rate (%)
15
10
5
Figure 3: Federal funds rate over electoral cycles
Democrat
Republican
2 4 6 8 10 12 14 16
Quarter
2 4 6 8 10 12 14 16
president
Barack Obama
Dwight Eisenhower
Dwight Eisenhower (2nd term)
George H.W. Bush
George W. Bush
George W. Bush (2nd term)
Gerald Ford
Jimmy Carter
Lyndon Johnson
Lyndon Johnson (2nd term)
Richard Nixon
Ronald Reagan
Ronald Reagan (2nd term)
William J. Clinton
William J. Clinton (2nd term)
LameDuck
1st term
2nd term
re-election.
While the data in Figures 2 and 3 are visually compelling, one objection may be
that the Fed is behaving differently under Democrats and Republicans because underlying
macoeconomic conditions differ when partisan control varies. To ensure
that the pattern identied above is not driven by differences in the underlying economic
conditions to which the Fed is responding. To that end, we estimate models
of the following form:
Ft = +b1E + b2D + b3E ∗ D + b4G + b5π + b6Ft−1 + ΩP + α + ϵ
F is the effective federal funds rate. E is an election counter which equals 1 in the
period that immediately follows a presidential election. E is then incremented by 1 in
every subsequent quarter until it reaches 16. D is a dummy variable equal to 1 when
a Democratic president is in office and 0 otherwise. P is a vector of dummy variables
that correspond to each presidential administration (i.e. 15 electoral cycles).
In addition to the partisan and electoral variables, we control for macro-economic
conditions by including the two Taylor-rule variables: output gap and ination. G is
the output gap, dened as deviation of the real GDP from real potential GDP (%). 4
We estimate models using four alternative measures of ination (π). First, we use the
4 Real potential GDP represents real GDP under conditions of full employment. Estimates are from
the Congressional Budget Office.
9

Figure 4: Federal funds rate over time
annualized rate of ination (consummer price index for all urban products). en,
to account for the possibility that the Fed may be forward-looking, we substitute π
for one of three measures of inationary expectations. πe H is the median expected
price change (12 months) obtained from a household survey conducted by the Survey
Research Center at the University of Michigan. πe P is the median 10-year ination
expectation from the Survey of Professional Forecasters (Philadelphia Fed). πe C is a
model-based measure of inationary expecations calculated for the 10-year horizon
by the Cleveland Fed. 5 6
Finally, to ensure that the Fed is not simply responding to differences in scal
policy by incumbent Republicans and Democrats, in some of our models we include
controls for government expeditures to GDP, as well as government debt to GDP.
Sources for the inationary expectations variables are noted above. All other data
are from the FRED database at the Federal Reserve Bank of St. Louis. All variables
are measured at quarterly intervals.
If our argument is correct, the coefficient on the election variable, which captures
the estimated effect of a movement toward an election when Democrat =0, ought to
be negative and statistically signicant and the coefficient on the interaction term
ought to be positive and large compared to the coefficient on election. Table 1 shows
5 http://www.clevelandfed.org/research/commentary/2009/0809.cfm
6 Models were estimated with various lags on the G and π variables without affecting our conclusions
substantively. ose results are omitted for brevity.
10

that, for the most part, both of these expectations are fullled across a number of
specications. In Model 1 the coefficient on Election is negative and statistically signicant
and the co-efficient on the interaction is positive and roughly twice as large
as the coefficient on Election. is model essentially summarizes the plots in Figure
3: on average interest rates drop over the course of Republican administrations
but increase over the course of Democratic administrations. Row one of Table 2 reports
the marginal effect of a change in electoral quarter in Democratic and Republican
administrations based on Model 1. Note that the condence interval around the
estimated effect under Republican administrations is negative, but the condence
interval around the estimated effect under a Democratic administration is positive.
us, according to Model 1, interest rates go down as elections draw near when Republicans
control the White House, but they go up when elections draw near when
Democrats control the White House. is result is generally robust to the inclusion of
a control for ination (Model 2), and ination and the output gap (Model 3) - though
the interaction term is no longer statistically signicant in the latter case. Table two
shows, that the marginal effect of elections on the FFR when Republicans control the
White House in models 1 to 3, but the effect is positive (models 1 and 2) or at least
non-negative (model 3) when Democrats control the White House. Models 4 and
5 also control for broad measures of the scal balance. In model 5 we control for
both spending as a share of GDP and the Debt-to-GDP ratio and nd results that are
nearly identitical to model 1, except that the standard errors of our main variables of
interest are inated (a result, presumably, of fewer degrees of freedom).
3 the fed’s conditional reaction function
e previous section implicitly assumes that interest rates are driven primarily by
the electoral calendar, modied by the party of the president. is is an extreme
version of our argument. More plausibly, perhaps, the Fed’s reaction function may
be fundamentally similar to the Taylor rule, but strategic considerations may cause
the Fed to deviate from the textbook policies we would associate with a politically
disinterested central bank. If the Fed were operating according to the Taylor rule, it
would raise interest rates in response to increased ination and lower interest rates
in response to an decrease in the output gap. Empirically, we might capture such
behavior with a model such as:
Ft = a1G + a2π + a3Ft−1 + ΩP + α + ϵ
with the expectation that a1 > 0, a2 > 0. If the Fed behaves as an ination hawk,
the coefficient on the output gap would be close to zero and the coefficient on ination
11

Table 1: Relationship between federal funds rate and election cycle, conditional on
the party of the incumbent president.
Model 1 Model 2 Model 3 Model 4 Model 5
(Intercept) 1.968 ∗∗∗ 2.091 ∗∗∗ 1.896 ∗∗∗ 0.545 −1.015
(0.515) (0.487) (0.412) (3.054) (3.812)
FFRt−1 0.797 ∗∗∗ 0.711 ∗∗∗ 0.732 ∗∗∗ 0.736 ∗∗∗ 0.703 ∗∗∗
(0.056) (0.058) (0.050) (0.050) (0.058)
Democrat −2.222 ∗∗∗ −2.488 ∗∗∗ −0.916 −2.187 −3.859
(0.542) (0.535) (0.619) (3.244) (3.152)
Election −0.062 ∗∗∗ −0.061 ∗∗∗ −0.034 ∗ −0.045 −0.078 †
(0.018) (0.017) (0.016) (0.031) (0.041)
Democrat × Election 0.119 ∗∗∗ 0.110 ∗∗ 0.065 0.069 0.119 †
(0.034) (0.034) (0.040) (0.045) (0.061)
π 0.150 ∗∗∗ 0.111 ∗∗∗ 0.110 ∗∗∗ 0.121 ∗∗
(0.033) (0.031) (0.030) (0.037)
Y-gap 0.208 ∗∗∗ 0.225 ∗∗∗ 0.259 ∗∗∗
(0.051) (0.047) (0.065)
Expenditure / GDP 10.046 28.054
(22.807) (37.585)
Debt / GDP −0.171
(0.474)
N 225 225 225 225 179
R 2 0.940 0.945 0.953 0.953 0.948
adj. R 2 0.935 0.940 0.949 0.949 0.942
Resid. sd 0.869 0.832 0.769 0.770 0.836
Robust standard errors in parentheses. Administration dummies omitted.
† signicant at p < .10; ∗ p < .05; ∗∗ p < .01; ∗∗∗ p < .001
would be large. If the Fed is more concerned about shortfalls in output than ination,
the converse would be true - the coefficient on the output gap would be large and the
coefficient on ination would be close to zero. e traditional PBC model would
predict that a dependent central bank would act less and less like an ination hawk
as elections draw near. us, a1 and a2 are conditional on the electoral calendar. In
addition, our argument suggests that the conditioning effect of the electoral calendar
is different when Republicans control the White House than when Democrats do. e
appropriate conditional model, therefore, is:
12

Table 2: Marginal effect of election proximity on federal funds rate.
Democrat Republican
M.E. 90% C.I. M.E. 90% C.I.
Model 1 0.057 [0.011 , 0.103] -0.062 [-0.091 , -0.032]
Model 2 0.049 [0.004 , 0.094] -0.061 [-0.089 , -0.033]
Model 3 0.031 [-0.02 , 0.083] -0.034 [-0.06 , -0.009]
Model 4 0.024 [-0.008 , 0.055] -0.045 [-0.097 , 0.006]
Model 5 0.041 [-0.004 , 0.086] -0.078 [-0.146 , -0.01]
Ft = bππ + bπEπE + bπDπD + bπEDπED
+ bGG + bGEGE + bGDGD + bGDEGDE
+ bEE + bDD + bDEDE + b12Ft−1 + ΩP + α + ϵ
and the conditional effects of changes in ination are given by:
∂
∂π = bπ + bπEE + bπDD + bπEDED (1)
when Republicans are in office (D = 0) this simplies to
13
∂
∂π|D = 0 bπ + bπEE (2)
which is a straight line that summarizes how electoral proximity inuences the relationship
between ination and interest rates when Republicans control the White
House. If our argument is correct, the Fed ought to respond to increased ination less
aggressively as Republican incumbents draw closer to re-election. us, the slope parameter
( the cross derivative bπE) ought to be negative, or at least not positive. Table
3 suggests this is the case - the interaction term Election × π is negative and is statistically
signicant when ination or our measure of expected ination based on
household surveys is used.
When Democrats control the White House 1 simplies to:
∂
∂π|D = 1) = [bπ + bπD] + [bπE + bπED]E (3)
and if out argument is correct, the Fed should respond to increased ination more
aggressively as elections draws near. us, the slope parameter (the cross derivative

πE + bπED) ought to be positive). It is easy to see that in Table 3 the sum of the
coefficients for Election × π and Democrat × Election × π is positive.
Figure 5 plots equations 2 and 3 along with 95% condence intervals for the four
equations in Table 3 - which differ only in the measure for ination used. e positive
slopes on the gray lines suggest that, as the election approaches, the Fed becomes
an ination hawk if a Democrat is in office. e negative slope on the black lines
suggest that the association between interest rates and ination converges to zero as
Republican incumbents near re-election. e slope parameters in 2 and 3 will differ
by the value of the Democrat × Election × π coefficient in Table 3. Note that this
is consistently positive and statistically signicant except where the Cleveland Fed’s
measure of expected ination is used.
Some details depend on the measure of ination used. When ination or expected
ination based on household survey are used, there is a signicant and positive
relationship between ination and interest rates in the later portion of a Democratic
administration. is is not the case under Republicans. 7 When either the survey
of nancial professionals or the Cleveland Fed’s model-based variable are used to
measure expected ination, there is a statistically signicant link between ination
and interest rates only when Democrats control the White House. Whichever set
of measures are used, the Fed appears to be a conditional ination hawk. e top
panels of Figure 5 suggest that the Fed turns off its responsiveness to ination when
Republicans are facing re-election, and turns on its responsivenss to ination when
Democrats are facing re-election. e bottom panels suggest that the Fed places little
or no weight on hitting its ination target when Republicans are in office, but is quite
sensitive to ination when Democrats are in office - especially as elections approach.
Our model also makes conditional statements about the relationship between interest
rates and the output gap, but the modifying effect of party operates differently.
When the Fed acts as an ination hawk it places less weight on hitting its ination
target. Under such conditions, we expect the Fed to be relatively insensitive to the
output gap as it shis its attention toward ination. Consequently we should observe
a weakening of the relationship between interest rates and the output gap when
Democrats are in office and the election draws near. Conversely, the Fed should react
strongly to the output gap when elections approach and the incumbent is Republican.
Figure 8 reports lines analogous to equations 2 and 3 for the effect of the output
gap on interest rates along with 95% condence intervals. e black lines show that,
regardless of how ination is measured, interest rates are positively associated with
the output gap in pre-electoral periods. e coefficient on Election×Y gap in Table 3
7 Conversely, there is a signicant and positive relationship between ination and interest rates in
the post electoral period only when Republicans are in office. is is consistent with the idea that the
Fed deliberately contracts the economy early in a Republican administration so that the economy will
bounce back in time for elections.
14

Table 3: Relationship between the federal funds rate and Taylor-rule variables, conditional
on electoral cycles and the president’s party.
π π e H π e C π e P
(Intercept) 2.724 ∗∗∗ 2.035 ∗∗ 0.485 −0.987
(0.529) (0.720) (1.186) (1.805)
FFRt−1 0.579 ∗∗∗ 0.546 ∗∗∗ 0.636 ∗∗∗ 0.690 ∗∗∗
(0.073) (0.083) (0.070) (0.049)
Democrat −0.649 0.516 −2.772 † −0.500
(0.680) (0.798) (1.428) (2.027)
Election 0.008 0.046 0.064 0.243
(0.016) (0.051) (0.052) (0.250)
π 0.236 ∗∗∗ 0.438 ∗∗ 0.611 ∗ 0.906
(0.064) (0.140) (0.301) (0.722)
Y-gap 0.044 0.067 0.057 0.169
(0.107) (0.109) (0.140) (0.171)
Democrat × Election −0.094 ∗∗ −0.224 ∗∗∗ −0.075 −0.491 †
(0.034) (0.065) (0.093) (0.272)
Democrat × π −0.460 ∗ −0.727 ∗ 0.266 −0.151
(0.199) (0.318) (0.374) (0.768)
Election × π −0.016 ∗∗∗ −0.027 ∗ −0.026 −0.100
(0.005) (0.012) (0.017) (0.101)
Democrat × Y-gap 0.251 † 0.191 −0.133 −0.105
(0.133) (0.130) (0.165) (0.210)
Election × Y-gap 0.026 ∗ 0.024 ∗ 0.030 ∗ 0.016
(0.012) (0.010) (0.012) (0.012)
Democrat × Election × π 0.056 ∗∗∗ 0.081 ∗∗∗ 0.051 0.216 †
(0.017) (0.023) (0.034) (0.111)
Democrat × Election × Y-gap −0.032 ∗ −0.023 † −0.034 ∗∗ −0.016
(0.016) (0.014) (0.013) (0.012)
N 225 203 116 77
R 2 0.963 0.961 0.979 0.979
adj. R 2 0.958 0.955 0.975 0.973
Resid. sd 0.695 0.719 0.481 0.322
Robust standard errors in parentheses. Administration dummies omitted.
† signicant at p < .10; ∗ p < .05; ∗∗ p < .01; ∗∗∗ p < .001
15

Figure 5: Marginal effect of ination on the federal funds rate, conditional on the
election calendar and the partisanship of the sitting president, with 95% Condence
intervals..
Marginal effect of inflation on FFR
0.6
0.4
0.2
0.0
−0.2
−0.4
1.5
1.0
0.5
0.0
Inflation
Cleveland
0.8
0.6
0.4
0.2
0.0
−0.2
−0.4
−0.6
3
2
1
0
−1
−2
−3
Households
Professionals
2 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16
Election proximity
Party
Republican
Democrat
show that the slope of these lines is statistically signicant, except when the survey of
professionals measure is used to measure expected ination. e results for the case
where Democrats control the White House differ slightly depending on the measure
of ination used. e bottom panel of 8 suggests that the Fed always turns a deaf ear
to the output gap when Democrats control the White House. e top panel suggests
that this is only the case when Democratic incumbents near re-election. Once again,
the coefficients on the triple interaction term Democrat × Election × Y gap are
signicantly different from zero (once again with the exception of the fourth measure
of expected ination). is indicates that the slopes of the black and gray lines differ
from each other in the statistical sense. at is, the effect of the electoral calendar on
the Fed’s reaction to the output gap depends on the party of the President.
16

4 robustness checks
We conduct additional robustness checks to see if the results presented in table 3
are sensitive to various research design choices. e results are presented in table 4.
Model 1 reproduces Model 1 from Table 1. For Model 2 we we re-estimate the model,
but substitute a set of Fed Chairmen dummies for presidential administration dummies
for a dummies. For Model 3 we estimate the model with both administration
and chairmen dummies. Finally, in Model 4 we reintroduce the debt and expenditures
control variables used in the rst section of the paper to see if our results are
driven by the failure to control for scal policy. e marginal effects of output gap
and ination for these four new models are drawn in gures 7 and 6. e marginal
effect of output gap on the FFR under Democratic administration becomes statistically
signicant in two of the specications (models 3 and 4), but its slope remains
nearly at. Aside from this minor change, the rest of the results remain very similar.
In addition, we considered the possibility that certain administrations might
be driving our results. Prior work suggests that Eisenhower behaved in a way that
was quite different from other post-war Republican presidents and it is possible that
the independence gained through the 1951 Treasury-Fed Accord did not inuence
behavior immediately. If this is true, inclusion of the Eisenhower administrations
might weaker our results. In contrast, the Carter and rst Reagan administrations
might appear to t our predictions too well. Consequently, we experimented with
dropping these administrations individually and in various combinations and found
little change in the results.
5 empirical results recap
We presented results from a set of simple OLS regressions using data on more than
ve decades of Fed activity. We nd that (1) the Fed increases interest rates before
elections when Democrats are in office, but (2) lowers them when Republicans
are vying for re-election; (3) the Fed seems to react to inationary pressures when
Democrats are in office, especially when elections are near; but (4) does not react to
inationary pressures when Republicans are facing re-election; (5) the Fed is insensitive
to the output gap when Democratic presidents are standing for re-election; but
is (6) more sensitive to the difference between realized and potential GDP at the end
of a Republican’s term.
All of these results are consistent with our argument. But existing explanations
are only consistent with some of these results. If the Fed were an unconditional in-
ation hawk and both parties were opportunistic vote maximizers, we would expect
to observe ndings (1), (3), and (5) but not (2),(4), and (6). If the Fed was simply not
17

Figure 6: Alternative specications: Marginal effect of ination on the federal funds
rate, conditional on the election calendar and the partisanship of the sitting president,
with 95% Condence intervals..
Marginal effect of inflation on FFR
0.6
0.4
0.2
0.0
−0.2
−0.4
0.6
0.4
0.2
0.0
−0.2
−0.4
Model 1
Model 3
2 4 6 8 10 12 14 16
0.4
0.3
0.2
0.1
0.0
−0.1
0.6
0.4
0.2
0.0
−0.2
−0.4
−0.6
Election proximity
Model 2
Model 4
2 4 6 8 10 12 14 16
18
Party
Republican
Democrat

Figure 7: Alternative specications: Marginal effect of output gap on the federal funds
rate, conditional on the election calendar and the partisanship of the sitting president,
with 95% Condence intervals..
Marginal effect of output gap on FFR
0.8
0.6
0.4
0.2
0.0
−0.2
0.8
0.6
0.4
0.2
0.0
−0.2
Model 1
Model 3
Model 2
Model 4
2 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16
Election proximity
19
Party
Republican
Democrat

independent and bent to the will of opportunistic leaders in both parties we would
expect to observe (2), (4), and (5), but not (1), (3), and (6). If the Fed was an unconditional
ination hawk in a world where the partisan model operated, we would
not see a connection between the Fed’s reaction function and the electoral calendar
and we certainly would not observe (2), (3), and (5). If this last world pertained and
the Fed knew something about the inationary tendencies of the Democrats compared
to the Republicans that was not captured in the measures of expected ination
then we might observe (1), (2), and (3) but not (4) and (5) - and certainly not (4) and
(6) together. at is, it is possible that the Fed charges Democrats an interest rate
premium because it believes measures of expected ination do not fully captures the
policy differences between the parties. If this were true the Fed would always react to
changes in both ination and the output gap but the magnitude (but not signicance)
of the coefficients would depend on the party that controls the White House. In other
words, the lines in the marginal effects graphs would not cross, and the black lines
capturing the reaction function for Republicans would be parallel to the x-axis.
6 conclusion: does the fed tip the presidential electoral
scales?
e Fed has macroeconomic policy preferences that are closer to the median of the
Republican party than to the median of the Democratic party. A partially independent
central bank will, all else equal, set policies that are a weighted average of the
party in power and its own preferences. Consequently, in normal times, the Fed expects
it to be easier to accomplish its policy goals when Republicans control the White
House than when Democrats do. Because voters reward pre-electoral expansions in
output, strategic central bankers face a trade-off when Republicans are in power. Do
they stick to their anti-inationary “guns” or do they compromise in the short-run
in order to increase the probability that policy goals in the future will be easier to accomplish.
When Democrats are in the White House the Fed faces no such trade-off.
Acting as a good ination hawk now has the added benet of increasing the likelihood
that they will have a party in power in the future that requires less accommodation.
e choice confronting partially independent strategic central bankers is simple,
compromise now, or compromise later. Our results suggest that since achieving
operational independence in the middle of the last century, the Fed has consistently
chosen the former. e behavior we have observed is consistent with the possibility
that the Fed seeks to aid the election and re-elction of Republican presidents.
We have not examined whether the difference in the Fed’s reaction function under
Democrats and Republicans has had an electoral impact. However, a glimpse
at the last century of American history is suggestive. In the half century since the
20

Figure 8: Marginal effect of output gap on the federal funds rate, conditional on the
election calendar and the partisanship of the sitting president, with 95% Condence
intervals..
Marginal effect of output gap on FFR
0.6
0.4
0.2
0.0
−0.2
0.6
0.4
0.2
0.0
−0.2
Inflation
Cleveland
Households
Professionals
2 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16
Election proximity
Party
Republican
Democrat
22

Table 4: Alternative specications: Relationship between the federal funds rate and
Taylor-rule variables, conditional on electoral cycles and the president’s party.
Model 1 Model 2 Model 3 Model 4
(Intercept) 2.724 ∗∗∗ 0.050 3.389 ∗∗∗ 1.184
(0.529) (0.266) (0.737) (2.617)
FFRt−1 0.579 ∗∗∗ 0.827 ∗∗∗ 0.538 ∗∗∗ 0.520 ∗∗∗
(0.073) (0.045) (0.082) (0.083)
Democrat −0.649 0.757 ∗ −1.523 −6.451 †
(0.680) (0.338) (1.142) (3.593)
Election 0.008 0.038 † 0.001 −0.071 †
(0.016) (0.021) (0.019) (0.042)
π 0.236 ∗∗∗ 0.217 ∗∗ 0.227 ∗∗∗ 0.213 ∗∗
(0.064) (0.067) (0.062) (0.071)
Y-gap 0.044 0.221 ∗ −0.052 −0.102
(0.107) (0.102) (0.121) (0.136)
Democrat × Election −0.094 ∗∗ −0.067 † −0.091 † −0.071
(0.034) (0.035) (0.049) (0.045)
Democrat × π −0.460 ∗ −0.181 −0.431 ∗ −0.549 ∗
(0.199) (0.127) (0.184) (0.220)
Election × π −0.016 ∗∗∗ −0.012 ∗ −0.017 ∗∗∗ −0.014 ∗∗
(0.005) (0.005) (0.005) (0.005)
Democrat × Y-gap 0.251 † −0.151 0.397 ∗ 0.356 ∗
(0.133) (0.121) (0.163) (0.162)
Election × Y-gap 0.026 ∗ −0.006 0.038 ∗∗ 0.047 ∗∗
(0.012) (0.009) (0.014) (0.017)
Democrat × Election × π 0.056 ∗∗∗ 0.021 0.056 ∗∗ 0.065 ∗∗∗
(0.017) (0.015) (0.018) (0.018)
Democrat × Election × Y-gap −0.032 ∗ 0.008 −0.043 ∗ −0.041 ∗
(0.016) (0.014) (0.018) (0.019)
Debt / GDP 0.752
(0.531)
Expenditures / GDP 2.751
(24.057)
N 225 225 225 179
R 2 0.963 0.949 0.965 0.960
adj. R 2 0.958 0.945 0.960 0.954
Resid. sd 0.695 0.797 0.684 0.749
Robust standard errors in parentheses. Administration and chairman dummies omitted.
† signicant at p < .10; ∗ p < .05; ∗∗ p < .01; ∗∗∗ p < .001
23

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