Rising fiscal uncertainty ahead of the November elections and lame-duck period could create the climate for the Federal Reserve Board to take action to help the U.S. economy. But as the clock ticks toward November, it will be harder for the central bank to do so without drawing criticism that it’s making political moves to affect the outcome.
The central bank guards its political independence. Over the past year, however, it has been thrust into the political spotlight as Republicans ramped up criticism of its actions and intervention in the economy. Among the GOP charges, the Fed is accused of unfairly and inappropriately backing the Obama administration’s goals. In January, Rep. Scott Garrett, R-N.J., said he was “truly taken aback” by a Fed white paper detailing recommendations to shore up the struggling housing sector. “If you didn’t advocate for, you certainly mirrored much of the positions of this administration,” Garrett said.
The central bank, of course, balks at accusations that it is dabbling in politics. Even if the Fed says it stays out of political debates, some believe the stepped-up Republican attacks and Fed response will make the bank increasingly unlikely to undertake new policy programs as the year progresses.
“If the Fed were to act on monetary policy in the second half of the year, they would just be accused of trying to favor the incumbent,” said Vince Reinhart, chief U.S. economist at Morgan Stanley and a former Fed staffer.
Even though Fed Chairman Ben Bernanke says that the bank is “entirely prepared” to take further balance-sheet action if the economy deteriorates--and there’s no reason to doubt he means it-- the threshold for taking such action may be higher in an election year. “Ideally, they don’t want to put themselves needlessly in the spotlight if they don’t have to, so I think they are going to err on the more cautious side [this year],” said Joe LaVorgna, chief U.S. economist at Deutsche Bank.
GOP calls to end the Fed’s dual mandate or to remove some of its power may also raise that threshold for action. “My bet is, deep down they are just terrified of the possibility of a Federal Reserve Reform Act of 2013,” Reinhart said. “I think it explains … [why] as we get closer to the election there will be radio silence from the Fed.”
So does the uncertainty surrounding what policymakers have dubbed the “fiscal cliff” facing the economy this year. The Bush-era tax cuts and payroll-tax holiday are set to expire on Jan. 1, 2013, the same day $1.2 trillion in automatic spending cuts are scheduled to kick in. The nonpartisan Congressional Budget Office estimates that GDP growth will slow and unemployment will climb by 1.1 percent next year if Congress fails to act. And whether lawmakers choose to stop the spending cuts and tax increases or let them kick in will depend on who wins the November elections.
“I think there is just simply enough uncertainty around the election and what implications are for the economy that indirectly it’s going to cause [the Fed] maybe to just sit and wait to see how things play out,” LaVorgna said.
That uncertainty is likely to have preelection economic consequences. Last summer’s debt-ceiling debacle shook markets and cost the United States its triple-A credit rating. The economy found its footing shortly after the debate, but there’s no guarantee that would happen again if a similar dispute over the country’s finances occurred.
Bernanke acknowledged that uncertainty over fiscal policy is figuring into the Fed’s calculus. The March minutes of the Federal Open Market Committee say “prospective fiscal tightening” is likely to slow the country’s economic expansion. And on Wednesday, Bernanke said that the Fed would “have to take fiscal policy into account to some extent” in its planning.
The Fed makes its policy decisions based on current economic data and its outlook. And despite concerns about the fiscal cliff, the most recent FOMC-member forecasts were positive about the trajectory of the recovery and justify the Fed’s decision to stand pat following its most recent policy-setting meeting.
Reinhart worries, however, that consideration of data alone, and not the politics of 2012, may cost the Fed a chance to shore up the economy. “I think there’s actually a risk, because they are so data dependent that they’ll miss the opportunity [to act] and then look back with regret,” he said. “If you see yourself being constrained, there’s an insurance element of acting early.”
There’s not much time--a mere six full months before the election. If the Fed wants to shore up the U.S. economy in advance of the year-end fiscal cliff, it will need to act soon, perhaps as early as its next meeting in June. But if the Fed takes action now, without clear evidence the economy had taken a turn for the worse, that, too, will bring harsh criticism.
So what’s a central bank to do? Jeffrey Greenberg, a U.S. economist at Nomura Securities International, says that the least controversial policy actions will be those that continue or pivot off current programs, such as maturity extension program Operation Twist, which is set to expire in June. “I don’t think there’s any way they would not be inclined to choose the path of least resistance.... The closer you get to the election ... it feels like it at least would be pitched in the press; or the reaction would be, the Fed’s trying to provide some last-minute stimulus for Obama prior to the election…. It makes sense to do what they can as early as possible.”