Political Pressure and the Economic Consequences on the U.S. Economy: A Quantitative Analysis

Introduction

Central bank independence is widely acknowledged as a cornerstone of sound macroeconomic policy, yet it often faces political interference. While the potential consequences of such interference have been extensively discussed, quantifying its economic impact remains a challenge due to the difficulty in systematically measuring political pressure. This study addresses this gap by developing a novel approach to isolate exogenous “political pressure shocks” on the Federal Reserve (Fed) and quantifying their effects on the U.S. economy.

New Data on Interactions between the President and the Fed:

A unique dataset of personal interactions between U.S. presidents and Fed officials is constructed using historical daily schedules of U.S. presidents from 1933 to 2016. This dataset captures over 800 personal interactions, providing a detailed record of presidential engagement with the Fed.

Narrative Approach Exploiting Nixon’s Pressure on the Fed:

To identify political pressure shocks, a narrative approach is employed, focusing on an increase in president–Fed interactions that plausibly took place solely to influence Fed policy. The focus is on the pressure exerted by President Richard Nixon on Fed Chair Arthur Burns in 1971, aiming to ease monetary policy for Nixon’s re-election. This narrative is supported by external evidence, including recordings from the “Nixon tapes” and entries in Arthur Burns’ personal diary.

Identification of Political Pressure Shocks:

A structural vector autoregression (SVAR) is employed to identify political pressure shocks. The SVAR includes president–Fed interactions as well as standard macro data. Narrative sign restrictions are imposed to define a political pressure shock as an increase in president-Fed interactions that eases policy in an inflationary way and constitutes the main contributor to the spike in president–Fed interactions in late 1971.

Macroeconomic Effects of Political Pressure Shocks:

The impulse response functions (IRFs) to a political pressure shock reveal substantial and persistent effects on the U.S. economy.

Inflation:

Political pressure shocks lead to a gradual and persistent increase in the price level, reaching a 5% higher price level after four years. This implies that exerting political pressure equivalent to 50% of Nixon’s pressure for six months permanently increases the US price level by more than 8%.

Inflation Expectations:

Political pressure shocks strongly impact inflation expectations and their dispersion. They raise both the mean and dispersion of inflation expectations, indicating that political pressure not only affects the expected inflation rate but also increases uncertainty about future inflation.

Real GDP and Fiscal Variables:

The responses of real GDP and fiscal variables are not distinguishable from zero, suggesting that political pressure primarily induces a price level effect. However, in some subsamples, a significant but negative response of real GDP is detected.

Comparison with Other Shocks:

The IRFs of inflation expectations to political pressure shocks are compared to those following a standard monetary policy easing shock and a generic “1971 inflationary shock.” Political pressure shocks have a stronger and more persistent impact on inflation expectations and their dispersion compared to other shocks.

Robustness Checks:

The results are robust to various sensitivity analyses and alternative identification strategies. For example, adding a second narrative episode based on President Lyndon B. Johnson’s pressure on Fed Chair William McChesney Martin strengthens the findings.

Conclusion:

This study provides novel quantitative evidence on the economic consequences of political pressure on the Fed within the U.S. economy over a long sample. The findings underscore the benefits of central bank independence and highlight the importance of insulating monetary policy from political interference. The analysis can inform policymakers and researchers about the potential effects of future episodes of U.S. presidents pressuring the Federal Reserve.