Fed Should Resist Politics, Not Play it

At the Federal Reserve's annual conference in Jackson Hole last month, all eyes were on Chair Kevin Warsh as he delivered his first speech. However, the real focus was on the Fed's rate decision, which is set to take place next week.

Kenneth Rogoff, a Harvard economist and lunchtime speaker at the event, offered some advice to a New York Times journalist: 'If they can possibly put it off till after the midterms, it would be good for the institution.'

Rogoff suggested that delaying the rate decision until after the midterm elections could be beneficial for the Fed's credibility. However, this approach is problematic and may undermine the Fed's independence.

A junior economist at the Fed wrote a paper in 1983, which is now considered foundational to the study of central bank credibility. The economist, also named Kenneth Rogoff, showed that economic outcomes would be better if the head of the central bank were more averse to inflation than the average person.

Claudia Sahm, chief economist at New Century Advisors and a former Federal Reserve economist, argues that playing politics to preserve independence is not a good strategy for the Fed. She notes that there is no evidence that the Fed's decisions are affected by the timing of elections and that the Fed has built-in protections to withstand political pressure.

Sahm points out that the exception - the Arthur Burns Fed supporting Nixon's reelection - resulted in higher inflation and should not be emulated at the Fed. She also notes that appeasement is not a strategy that works with the Trump administration, citing the attempted firing of Fed Governor Lisa Cook and the Department of Justice investigation of then-Chair Jerome Powell.

Sahm advises the Fed to forget the electoral calendar and stay focused on the economy, making decisions based on data rather than politics. She argues that credibility lives in what people believe the central bank will do under pressure, and it is precisely when the pressure is greatest that the Fed's credibility is won or lost.