(Bloomberg View) – Given Donald Trump's rather inconsistent and worrying statements about his plans for the Federal Reserve, it would be ironic if the central bank provided the impetus that carries him over the finish line in this November's presidential election. But there is a small chance that might happen.
The Fed is poised to raise interest rates again, after raising them in December for the first time in more than nine years. Janet Yellen, the Fed chair, said last month that if the economy continues to do reasonably well, the central bank will hike interest rates this summer or fall. Some non-hawkish Fed governors have echoed her statement. Markets seem to believe that the Fed is now serious about this.
QuickTake: The Fed lifts off
Why might this help Trump's presidential bid? Because rate increases have the capacity to hurt the economy. When Paul Volcker, Fed chairman at the time, raised rates sharply in the early 1980s to wring inflation out of the economy, two sharp recessions followed. Here's the history, in pictures:
Macroeconomists, as well as the general public, have widely interpreted this as clear evidence that rising rates can have a damping effect on economic activity. This episode was key to the development of New Keynesian models of monetary policy, which are now used by most central banks.
Volcker's rate hikes were enormous — about 10 percentage points. The Fed's current plans, which envision a few percentage points at most, might seem like small potatoes in comparison. But it isn't just rates themselves that matter for the economy; it's people's expectations of future rate increases.
If people see a Fed hike as a policy regime shift (the first in a long cycle of tightening) it could have the same effect as if all the tightening was done in a single day. In other words, the perception of a turning point might be a big event for markets and for the economy.
If growth did take a hit, it probably would be a windfall for Trump. Economic conditions don't necessarily determine the results of presidential elections, but they do appear to matter. If higher rates caused the perception of a policy regime shift, and that made growth decline in the coming months, that could make the difference in a very close election. It isn't a likely scenario, but it's possible.
In fact, there are allegations that the Fed has tipped the scales for Republicans in the past. Political scientists William Clark and Vincent Arel-Bundock wrote a paper in 2013 claiming exactly this. From their abstract:
We show evidence from the United States that interest rates (a) decline as elections approach when Republicans control the White House, but rise when Democrats do; and (b) are sensitive to the inflation rate (output gap) when Democrats (Republicans) are in the White House. Thus, the Federal Reserve is a conditional inflation hawk. Since the Fed became operationally independent in 1951, the Republicans have exhibited a decided electoral advantage in presidential politics.
The authors show how rates generally rose throughout the Kennedy, Johnson and Carter administrations, reaching their peak about the time Jimmy Carter was defeated by Ronald Reagan. But rates fell dramatically and steadily during the Reagan and George H.W. Bush administrations, and even more during the administration of George W. Bush.
