A Brief History of Fed Independence

The Federal Reserve announced a 0.25% interest rate cut following yesterday’s meeting.  The rate cut is no surprise to markets, and may even serve to briefly pacify President Trump, who has been extremely vocal about the request for such action. Many would argue that the President’s repeated request for interest rate cuts threatens to undermine the independence of the Federal Reserve which is a key component to keeping the current monetary system unbiased and nonpartisan.

The Federal Reserve has a relatively good track record of making independent decisions based on economic data, but there is a strong case to be made that the Federal Reserve acted in a partisan manner in the early 1970s, and the results were fairly disastrous.

The backstory begins with the 1960 presidential election, which pitted a relatively unknown, but vibrant, forty-three-year-old senator from Massachusetts named John F. Kennedy against Vice-President Richard Nixon.

As Burns predicted, in April, about six months before the 1960 election, the economy began to weaken. The downturn was relatively brief, but it was enough to sway potential voters from the incumbent party to Kennedy. Swing votes went to Kennedy, who won the election in dramatic fashion, carrying the popular vote by less than two-tenths of a percent.

Early in 1960, an economist named Arthur Burns had warned Nixon that an economic slowdown was probable later in the year that could derail his campaign. Burns was considered an expert on business cycles in the economy and was an ardent Republican supporter. As such, Burns suggested that action could be taken in advance of the dip to delay the downturn. Nixon relayed Burns’ recommendation to increase the money supply and increase government spending before the election, but his request fell on deaf ears. Nixon blamed his election loss on the Federal Reserve.

Eight years later, Nixon would get his redemption when he defeated Hubert Humphrey in the 1968 presidential election. A year after winning the election, Nixon rewarded Arthur Burns for his loyalty by appointing him to serve as the chairman of the Federal Reserve.

Burns and Nixon had witnessed firsthand the impact an economic downturn could have on a presidential election, and neither had any intention of letting it happen again. Shortly after taking the reins, Arthur Burns began engaging in abnormally loose monetary policies, such as money printing and low interest rates. In hindsight, it appears that Burns purposefully tried to juice the economy leading up to Nixon’s 1972 reelection at a time when the economy didn’t need such policies.

Burns’ loose policies served their political purpose: President Nixon was reelected in 1972. Burns appeared to take similar steps again leading up to the 1976 election, presumably to try to help Republicans retain control of the White House, but his efforts were unsuccessful (mostly because of Nixon’s resignation), and the Democratic candidate Jimmy Carter won the election.

Inflation ultimately ramped up following the loose monetary policies, leading to record high interest rates, a deep recession and economic hardships for the country later in the decade.

Burns received most of the blame for causing inflation because, in essence, he knew better. His policies serve as Exhibit A of how using economic policies for short-term political gain can cause long-term damage.  

Is this rate cut (and those to come) a repeat of the past? Is the Fed bowing to political pressure or did it learn from its predecessors?  Only time will tell. 

Whether or not the rate cut is warranted is another topic altogether, and will have to wait for a later blog post.

Any opinions are those of Brady Raanes and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Inclusion of the index is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. International investing involves special risks, including currency fluctuations, different financial accounting standards, and possible political and economic volatility. Commodities trading is generally considered speculative because of the significant potential for investment loss. The price of gold has been subject to dramatic price movements over short periods of time and may be affected by elements such as currency devaluations or revaluations, economic conditions within an individual country, trade imbalances, or trade or currency restrictions between countries.