Political Monetary
Cycles: The Independent Treasury versus the Federal Reserve
Jac C. Heckelman
and John H. Wood, Wake Forest University
The theory of political business cycles predicts incumbent politicians will alter their economic policies to spur short-run growth to attract additional votes during an election period. Following the election, policies will be altered to purposely lower inflation and growth to be able to restart the cycle later in their terms. Empirical evidence for growth cycles timed around elections has been scant. This has been interpreted alternatively as lack of an attempt at manipulation, or an attempted but failed manipulation of the economy.
One reason it is thought cycles are unlikely to hold is due to the particular institutional environments that make up federal governments. Typically, central banks are designed to be at least quasi-independent of elected officials precisely to insulate them from short-term political pressures. Furthermore, in the United States no single branch of government has complete control over fiscal instruments, and with monetary policy conducted by the independent Federal Reserve, the executive administration is not in position to drive the direction of the economy, despite public perceptions.
There has not been much emphasis on the possibility of historical political business cycles prior to the Keynesian Revolution, which placed strong emphasis on fiscal policy to direct the economy. The few studies conducted seem to reject cycles in GNP and inflation correlated with presidential elections. However, no study has yet undertaken a systematic approach to testing for policy cycles during this period. Our study will bridge this gap.
Monetary cycles may well be expected to occur before the creation of the Federal Reserve in 1913. Prior to the Fed, monetary policy was conducted through the Treasury, as part of the executive office. Thus, the president was in especially good position to create electoral cycles in money supply to temporarily boost economic activity. Furthermore, since the secretary of the Treasury is appointed by the president, he would also be dependent on presidential reelection to retain his position. Even after creation of the Fed, presidential influence on monetary policy remained, as the first Board included the secretary of Treasury and comptroller of currency as ex officio members.
We consider the periods of 1879-1914 until creation of the Fed, and 1914-1933 until abandonment of the gold standard. The start of our sample period coincides with the official beginning of the gold standard as required under the Resumption Act of 1875, so for consistency we will only consider policy under the gold standard, as removal of the fixed-exchange gold standard after 1933 would vastly alter the Fed’s abilities to control money supply and likely radically change their reaction function.
As a first test for the presence of a political monetary cycle, we use quarterly data on M2 taken from Friedman and Schwartz’ Monetary Statistics of the United States (1970). Our electoral variables are alternately defined as: 16 quarterly dummies over the four year presidential term, polychotomous distributed lags on the quarterly dummies, and several pre-specified cyclical patterns. We do not find strong evidence of electoral monetary cycles.
However, the monetary authorities do not directly control broad money aggregates. As a more direct test, we next Analyze reaction functions for endogenously derived monetary authority credit, using changes in high-powered money, gold holdings, national bank notes secured by U.S. bonds, and the accumulated budget surplus. Data are taken from various issues of the Treasury Annual Reports and Banking and Monetary Statistics. Our results indicate that both monetary institutions acted to stabilize monetary base growth, but the Fed was more active in also following interest rates and GNP growth. Electoral variables are not significant under the Treasury but the Fed may have consistently eased credit in the two quarters preceding each presidential election.