Is the Fed Political?

The Fed is supposed to be independent of the political process, but in reality that is probably not possible, given that its head is a political appointee. The chairman of the Federal Reserve Board, Ben Bernanke, was appointed by George W. Bush in 2006. You don’t appoint someone who is not on your team.

At this week’s FOMC meeting, the fed had to decide whether inflation was getting strong enough to justify an interest rate hike, or whether such a hike would depress the domestic economy too much. They decided to talk tough but actually do nothing.

By failing to raise rates, Bernanke allows inflation to creep up, saying (in deed, not in words), “we are not worried about it.” That means he doesn’t care if the weak dollar gets even weaker, eaten away by inflation. But since oil is priced internationally in dollars, failure to make a rate hike, even a small one, raises the price of oil. And that’s exactly what happened. It is up as much as $4 a barrel today to around $138.

The justification I have read for the Fed’s decision is that “core” inflation (exclusive of energy and food) is relatively manageable. Of course that begs the question of what planet FOMC members live on where energy and food “don’t count.”

But I think there was a more sinister motive at work, related to the fact that Bernanke is on the Bush team. To raise rates, even a quarter percent, would likely have prolonged the housing crisis. It would have raised mortgage rates and reduced the number of buyers, stifling any nascent recovery in the housing market.

The housing market is a huge domestic political issue. If housing does not recover by November, the Republicans are toast for sure. Inability to sell a house is not an abstract economic issue. It could mean that you are paying two mortgages, or it could mean you have to turn down a job that involves a relocation. If your mortgage is higher than what your house is worth, you can only pray for recovery of the housing market before you are forced into foreclosure. Big corporations like the new home builders are also feeling the pain. Lennar today posted large quarterly losses.

High gas prices hurt voters too, especially the less well-off who pay a higher percentage of their income on fuel. One of my students says she pays $130 to fill up her SUV and does that three times a week. That is a serious dent in anybody's budget. (Naturally I want to yell at her: “What are you doing with a stupid SUV?” But that’s like saying to a child who is in a fix, “You should have thought of that earlier!” Not helpful.).

But who is to blame for high gas prices? Why, it’s those pesky Arabs! And slithering speculators. And don’t forget those greasy oil companies!

Obviously then, for Bernanke, if he lets the dollar decline further, oil prices go up further, but it’s not his fault! It’s not the government’s fault. It’s not the Republicans’ fault. It’s somebody else’s fault. Easy choice to make.

But if he had raised rates, even a tiny bit, there would have been an effect on the housing market, probably negligible and short term, but the housing crisis then could clearly be pinned on him. Unacceptable choice. Because that means the housing crisis is the fault of the government and that would have repercussions at the ballot box in November. So Bernanke chose the course that least harms his political party.

Paradoxically, even if his choice was politically motivated, it will have a counterproductive effect. At some point of pain, which we are fast approaching, voters will realize that Republicans have no energy policy (other than to drill for oil on beaches and in national parks). That will kill them in November.