The moderators at Tuesday night's Republican debate spent a surprising amount of time talking about one of the least exciting but most important economic issues: monetary policy. During the course of the debate, Ben Carson, Ted Cruz, Rand Paul, and Chris Christie all commented on the policies of the Federal Reserve. And all agreed that the Fed was doing too much to try to support the economy. None spoke in defense of recent Fed policies to boost the economy by pumping money into the financial system.
Their economic arguments of these candidates were dubious, as we've argued here, here, and here. But the Republican Party's growing hawkishness on monetary issues also carries a huge political risk.
Low interest rates and loose money boost the economy, making it easy for incumbents to win reelection. Tight money has the opposite effect. So if Republicans turn monetary policy into a partisan issue — with Republican administrations adopting tight money policies and Democrats favoring looser money — they will be handing Democrats a huge electoral advantage.
Low interest rates are good for incumbents
History is full of examples of Federal Reserve decisions shaping the fortunes of presidents:
- The Federal Reserve and other monetary policymakers didn't respond aggressively enough to the 1929 stock market crash. The result: the Great Depression, the worst economic calamity in American history. The president who presided over this economic disaster, Herbert Hoover, lost in a landslide in 1932.
- President Richard Nixon pressured Fed Chair Arthur Burns to keep interest rates low in the months before the 1972 election. The tactic seems to have worked; Burns kept interest rates below 5 percent — down from 8 percent in 1970 — and Nixon cruised to a landslide reelection.
- In 1979, with inflation surging, President Jimmy Carter appointed inflation hawk Paul Volcker to lead the Fed. With Carter's blessing, Volcker boosted interest rates in an effort to fight inflation. Volcker ultimately won his war against inflation, but Carter's political career didn't survive. Volcker's policies contributed to the 1980 recession, allowing Ronald Reagan to beat Carter at the polls.
- In 1992, George H.W. Bush was running for reelection. The economy had just emerged from the 1991 recession, and Bush hoped Fed Chair Alan Greenspan would aggressively cut interest rates, boosting the economy and helping his reelection chances. Greenspan did cut rates, but not as aggressively as Bush had hoped. As Bush put it after he lost the election, "I reappointed him, and he disappointed me."
Reasonable people can disagree about the economic merits of the Fed's policies in some of these cases. But it's clear that politically speaking, looser money is better for the incumbent party. Loose money promotes a short-term economic boom that boosts incumbents' chances of reelection.
Inflation was too high in the 1970s. It's too low today.
Of course, lower interest rates aren't always a good idea. When inflation is high, cutting rates can make the problem worse. President Carter understood perfectly well that tight monetary policy could be bad for his political career, but he appointed an inflation hawk like Volcker anyway because he thought tough medicine was needed to combat the nation's inflation problem.
If today's economy looked like the economy of the 1970s, the Republicans' hawkish views would have a lot of merit. But today's economy is dramatically different from the economy of the Carter and Reagan years. Since the 2008 financial crisis, the inflation rate has averaged about 1.4 percent. That makes it the least inflationary period in a half century. And market forecasts suggest there's very little inflation on the horizon.
In that economic environment, pushing for tighter money isn't just bad politics, it's bad economics too. For example, in 2011 the European Central Bank believed that the worst of the eurozone recession had passed, so it raised interest rates. That proved to be a huge mistake that tipped the eurozone economy into a double-dip recession. Countries like Greece and Spain are still feeling the pain today.
Tight money policies could worsen the next recession
Fortunately, the economy seems to be healthy enough that a modest interest rate hike probably wouldn't tip us back into recession. Indeed, the Fed is expected to begin raising interest rates soon — perhaps as early as next month and almost certainly before Janet Yellen's term expires in 2018.
The larger danger is that tight money orthodoxy could prevent the Fed from responding effectively the next time a recession occurs under a Republican president. In the wake of the 2008 recession, Ben Bernanke aggressively eased monetary policy, cutting short-term interest rates to zero. Critics have derided these low rates as "artificial" and "extraordinary," but many economists believe Bernanke's decisive action saved the US from a much worse calamity.
And there's a lot of reason to think today's environment of low interest rates and low inflation will be with us for a long time to come. Japan has had near-zero interest rates and very low inflation for two decades. Interest rates and inflation are low in the eurozone, the United Kingdom, Canada, and other rich countries.
This means the next recession is likely to once again require the Fed to quickly cut interest rates to zero. If the chair of the Fed is a Republican who shares the monetary policy views of Rand Paul, Ben Carson, or Ted Cruz, there's a real risk the Fed won't respond quickly enough, leading to a more severe recession and a slower recovery.
Making monetary policy a partisan issue would be a disaster for Republicans
First and foremost, that would be a disaster for the country. But it would also be a political disaster for the party that controls the White House, because the performance of the economy is one of the biggest factors driving presidential elections. When the economy is doing well, the incumbent's party tends to win reelection. When the economy is doing poorly, voters like to throw out the incumbents and elect the other party.
So if monetary policy becomes a partisan issue — with Republicans favoring tight money and Democrats facing looser money — that will be bad for the reelection prospects of Republican presidents. Democratic presidents will enjoy the tailwinds that come from a favorable interest rate environment, while Republican presidents are forced to fight against the headwinds created by unnecessarily tight money.
And there's no reason monetary policy should be a partisan issue. We've already seen that Presidents Richard Nixon and George H.W. Bush lobbied the Fed for looser money during their presidencies. Ben Bernanke has become a villain for much of the right, but he was appointed to lead the Fed by a Republican president, George W. Bush, just 10 years ago.
Indeed, the 20th century's most prominent free market economist, Milton Friedman, famously argued that tight money had worsened the Great Depression. In 2000, he urged Japanese monetary authorities to undertake a program of quantitative easing that sounds a lot like the expansionary monetary policy the Bernanke Fed undertook a decade later.
Yet Friedman's intellectual heirs on the right, including National Review's Ramesh Ponnuru, the American Enterprise Institute's James Pethokoukis, and the Mercatus Center's Scott Sumner, seemed totally unrepresented on Tuesday's debate stage. It seems that tight money is becoming a Republican orthodoxy, and that would be not only an economic disaster for the country but a political disaster for the GOP.