President Trump’s criticism of Fed Chairman Jay Powell’s decision to raise interest rates was concerning for supporters of central bank independence, but he wouldn’t be the first president to attempt to influence the central bank’s policy decisions to boost his popularity. Both Lyndon Johnson and Richard Nixon attempted to influence the Fed’s monetary policies to benefit their domestic agendas.
Writing for ProMarket, Karsten Müller summarizes his research on the effects of impending, close elections on legislatures’ decisions to change macroprudential regulation. From the paper’s abstract,
A newly emerged consensus holds that policy makers should use macroprudential regulation to prevent financial crises or soften their impact on the real economy. Despite their widespread use, little is known about the political constraints that come with such tools. [Before close elections r]egulation is substantially less likely to tighten for tools aimed at mortgage and consumer credit, particularly in periods with optimistic growth forecasts, higher bank profitability, or an increasing credit-to-GDP gap…I find very limited evidence that central bank independence has a moderating effect on this electoral cycle in prudential tools. Taken at face value, these results suggest that time-varying financial regulation may be subject to more severe political pressures than previously acknowledged.
Müller finds that changes in economic fundamentals can’t explain these changes.
Legislators’ desire to keep the good times rolling to boost their electoral prospects creates incentives to not only scale back existing macroprudential regulations, but also block new ones.
During good times, policymakers should “lean against the wind” and prepare for an economic downturn by implementing measures like higher capital requirements. Instead, legislators facing close elections do the opposite.
Sector-specific capital requirements are less likely to be tightened when economic growth is higher (and projected to be higher in the future) and banks are more profitable. Regulation is also less likely to tighten when the credit-to-GDP gap is growing. This finding is particularly troubling because the credit-to-GDP gap is arguably the most widely used metric to gauge the buildup of financial vulnerabilities, which suggests that the electoral cycle makes regulation more procyclical.
While central bank independence is positively correlated with countercyclical monetary policy, independence fails to mitigate the political influences on macroprudential policies implemented by the legislature.
While many reforms implemented in the 2010 Dodd-Frank Act have been criticized for putting too much power in the hands of agencies “insulat[ed] from democratic accountability” (the Consumer Financial Protection Bureau is a frequent target of this criticism), these findings problematize the benefits of putting the burdens of macroprudential policy on the legislature.
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