The current work is a review of a scientific article.
Drechsel, T. (2024). Assessing the consequences of political pressure on the Fed. University of Maryland and CEPR
In August 2015, the National Bank of Kazakhstan announced a transition to an inflation targeting policy. At that time, this decision did not immediately meet with public approval, but now - almost 9 years later - the advantages of the decision have become more clear: the exchange rate, now occurring on the basis of market factors (instead of devaluation), have become more predictable; The interest and financial literacy of the population about the exchange rate formation and factors of inflation increased, the instruments of monetary policy became clear, and more active interaction of the Central Bank with the public began to be practiced. But despite all the above advantages, it is obvious that some issues of the ongoing monetary policy remain on the agenda today. One such issue is the independence of the Central Bank.
Extensive empirical research, both old and recent, confirms the benefits of a politically independent central bank for sustainable inflation (Alesina and Summers, 1993; Dincer and Eichengreen, 2014).
But what is the “independence” of the central bank and what is the “pressure” on the central bank? One of the first studies that attempted to assess the pressure on the central bank was the study of Wallace and Sargent (1961). The authors examined the “pressure” of the fiscal authority as a manifestation of fiscal activity - rapidly growing government spending and a high level of public debt.
But what if pressure is exerted not through fiscal policy instruments, but directly, on a representative of the central bank, following the example of modern Turkey? You could also find recent examples of such pressure in 2022-2023 in Kazakhstan, when representatives of the Minitry of National Economy or the Ministry of Finance gave “advice” to representatives of the National Bank to reduce the base interest rate.
This type of pressure has not been studied previously, since it seemed that there was no way to separate a politically motivated (made under someone else’s pressure) decision of the central bank from a simply “wrong” decision of the central bank against the background, for example, of incompetence of the head of the Central Bank.
However, in January of this year, University of Maryland economist Thomas Drechsel decided to take on this issue and assess the political pressure on Fed chairmen by compiling an extensive database of the number of times and hours of interaction between US presidents and Fed officials from 1933 to 2016 (that is, from the presidency of Roosevelt to Obama).
Thomas Drechsel identified 800 meetings between presidents and Fed officials during the period 1933-2016. He obtained such information by collecting archival data on the daily schedule of all US presidents from Roosevelt to Obama.
The average duration of a meeting between the president and a Fed representative was 53 minutes. At the same time, 36% of meetings were carried out in the form of one-on-one business meetings (president and chairman of the Federal Reserve), 11% - in the form of informal meetings on weekends, 16% - in public places, such as lunches. In 92% of cases, US presidents interacted directly with the Fed Chairmen, and only in 8% of cases the meeting took place with any other Fed official.
One interesting outlier in Drexel's sample was President Richard Nixon's relationship with Fed Chairman Arthur Burns. During Nixon's presidency, they met 160 times, and the total duration of their meetings was 190 hours (almost 8 days of continuous communication)! It is worth noting here that Richard Nixon was the 37th President of the United States in the period 1969-1974, and Arthur Burns was appointed by Nixon as Chairman of the Federal Reserve in 1970 and served in this post until 1978.
Both Nixon and Burns became “bitter” chapters in US history: the first was remembered for the Watergate Scandal and was accused of secretly wiretapping his opponents, and the second was the worst Fed chairman who pursued a soft monetary policy in conditions of growing inflation. Thus, at the end of 1971, the Fed lowered the interest rate by 150 base points, and in total monetary easing from February 1970 to November 1972, when Nixon won the election, was, according to Drexel’s calculations, about 400 base points (annual inflation rose from 3.3% in 1972 to 6.2% in 1973)
But we should also take into account that Nixon's presidency fell on a difficult period for the US economy, when the usual Phillips curve stopped working: the inflation rate grew along with the unemployment rate - stagflation began. Only 35 years later, in 1995, Robert Lucas would discover one of the theoretical concepts that explains the failures of Nixon's economic policies. That concept was a new type of expectations of economic agents - rational expectations.
But even so, Burns's policy seemed strange, given that amont economists Arthur Burns was a revered professor with a clear understanding of the impact of monetary policy on the economy. It was Burns who taught Milton Friedman and influenced him -the man who is now known as the “father of monetarism.”
Burns' policy became clear a little later, when some information from his personal diary was published. For example, Burns wrote in his diary that “the President will do anything to get re-elected” and that Nixon urged him to “begin expanding the money supply and predicting disaster if it is not increased” (Ferrel, 2010). From the diary it becomes clear that Burns was often against some decisions of Nixon.
And here it should be noted that not everyone was blind, ignoring the pressure from Nixon on the Fed chairman. Media reports from the period indicate that the pressure on the Fed was well known. Nixon practiced to challenge Burns' views on monetary policy in the media. For example, during a press conference in August 1971, he praised dovish monetary policy, stating "(...) you have seen an expansionary monetary policy, and that is one of the reasons we have had an expansionary economy last 6 months." and criticizes Burns' position.
Nixon's rhetoric and behavior completely undermined public confidence in the Fed's policies in general and in Burns in particular. Drechsel, based on the local projection method, constructed impulse responses of inflation and inflation expectations in response to a simple “monetary shock” and in response to a “monetary shock under political pressure.”
The results showed that the central bank's rate cut for political reasons by 100 bp. leads to an increase in the general price level in the economy by 5% after 4 years. If similar monetary easing occurs without fiscal aiuthorities' intervention, prices increase by no more than 1%. The picture is similar with inflation expectations: after 5-6 years, inflation expectations are 4% higher if the monetary shock was made under political pressure, and do not exceed 1% if the monetary shock was an “independent” decision of the Fed.
Drechsel points out that the transmission mechanism for monetary decisions made for political reasons differs from the traditional mechanism. The population’s awareness that the central bank is not independent in its actions increases the inflationary expectations of economic agents, and at the same time suppresses the growth of their activity - as a result, the reaction of GDP and unemployment to the politically motivated weakening of monetary policy turns out to be weak.
Drechsel's research once again proves that politicians' reliance on gains from intervention in monetary policy and public censure of central bank representatives ultimately results in high inflation in the absence of the desired sustainable economic growth.
By the way, trust in the Fed as an independent body was established in the United States during the chairmanship of Paul Volcker, who replaced Burns in 1979. Volcker is remembered in US history as the “inflation killer” and the toughest Fed chairman. By the beginning of 1980, annual inflation in the United States had already exceeded 14%. Therefore, Volcker was decisive from the very beginning of his chairmanship at the Fed - he raised the interest rate to 20% in the early 80s, and moreover, openly told everyone that the Fed would no longer print money to support the economy. With his harsh, although necessary, measures, Volcker drove the US economy into depression, which was later called the “Volcker's shock.” It was he who defended the position of “independence” of the Fed in making decisions on monetary policy, “nailing” Americans’ inflation expectations for many years to come.
Note that during 8 years of chairmanship of the Fed, Volcker interacted with the US President only 20 hours or 50 meetings (for comparison, let us repeat that Burns had 190 hours of communication with Nixon or 160 meetings), while the average duration of Volcker’s meetings with the President was 20 minutes.
