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Week of November 5, 2012

Research

U-M study finds partisan bias with monetary policy at Federal Reserve Bank

With the elections less than one week away, it is worth considering that the party of the president influences the policy behavior of the Federal Reserve Bank, according to a new U-M study.

The Federal Reserve Bank increases interest rates before the presidential elections when Democrats are in office, but lowers the rates when Republicans control the White House. The independent bank finds it easier to accomplish its policy goals when Republicans control the White House than when Democrats do, the researchers noted.

“The behavior we have observed is consistent with the possibility that the Fed seeks to aid the election and re-election of Republican presidents,” says U-M political scientist William Clark and the study’s lead author.

These findings can be found in a new paper, which Clark co-wrote with doctoral student Vincent Arel-Bundock, due to appear in an upcoming issue of Economics & Politics.

Examining the Federal Funds Rates between 1951-2008, the White House has been occupied by a Republican for almost two-thirds of the time, the study showed. Every Republican president to run for re-election since the Fed became operationally independent in 1951 — with the exception of George Herbert Walker Bush — was re-elected. In contrast, Bill Clinton was the only Democratic president to serve two full terms after the Fed became independent.

Clark notes that the Fed’s partisan bias with its policies could be attributed to independent central banks being run by conservative bankers. Frequently, they are “more eager to thwart the electorally-motivated expansions by left-wing governments before elections.”

“We observe the counter-intuitive partisan difference that right wing governments preside over more lax fiscal and monetary policies than left-wing governments,” the authors wrote.

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