The Political Business Cycle

It's September 1992 And Federal Reserve chairman Alan Greenspan announces a big increase in the discount rate and bank reserve requirements. Interest rates and unemployment increases, the economy goes into a deeper recession, and Bush is defeated. But Greenspan has no apologies: as a nonpartisan servant of the public, his policies must "focus only on what's good for the economic health of America. The boom was hurting our country; we had to purge the malinvestments to make way for long-lasting growth."

That scenario is about as likely, of course, as Madonna joining Mother Theresa. Greenspan will do what Fed chairmen always do: the White House's bidding. Thus he has artificially lowered interest rates for most of 1991, leading to more economic troubles after the election.

The first economists to examine thoroughly the political business cycle, Stephen Haynes and Joe Stone, found "strong four-year cycles in unemployment and inflation, with peaks and troughs consistent with the four-year electoral cycle" from 1951 through 1980, the last year they looked at.

Why isn't this as big a scandal as the October Surprise? It almost was, in the early 1970s, when Richard Nixon appointed Arthur F. Burns, beloved economist and party hack – the Greenspan of his time – as chairman of the Fed's board of governors. In making the announcement, Nixon said, "I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed." The audience applauded, and Nixon turned to his old friend. "You see, Dr. Burns, that is a standing vote for lower interest rates and more money." It was the only vote needed.

In August 1971, with price inflation running at 4%, Nixon severed the dollar's final tie to gold and imposed price and wage controls. Under that stunningly opportunistic cover, Burns hiked money growth from 3.2% in the last quarter of 1971 to 11% in the first quarter of 1972, the election year. The economy boomed, prices were artificially restrained, and Nixon was reelected in a landslide. After the election, he removed some of the controls, price inflation soared to 12%, and Burns stepped on the monetary brakes, bringing on a recession.

Such economic offenses are more difficult to prove these days, since Burns abolished the practice of taking detailed minutes of the meetings of the Federal Open Market Committee.

Recorded or not, however, Greenspan also does the president's bidding. After all, as Arthur Burns once explained to a German reporter, "If the chairman didn't do what the president wanted, the Federal Reserve would lose its independence." Steve Axilrod, former staff head of the Open Market Committee now making his fortune on Wall Street, told me that was "the most damaging statement ever made by anyone connected with the central bank." Damaging, of course, because true.

The Fed serves two masters, the government and the big banks. In matters of the government's core interests, i.e., elections, it calls the tunes – not that it gets any opposition from the big banks on inflating.

At its inception, the Federal Reserve's proponents said it would be above politics. Thus its "independence." But this has always been disinformation. The Fed is the quintessentially political agency in D.C.

Not that Fed policy is the only way Washington, D.C., gets its way. For example, politicians also have fiscal policy at their disposal, which is to say they can spend more of our money on public works, welfare, etc. And trade regulators can wipe out whole classes of imports to create boomlets for select domestic manufacturers.

All these strategies seem to improve the economy, only later turning out to be deadly. By then, the politicians are safely reelected.

The cost in human suffering of the political business cycle and related political manipulations is incalculable – but we can know that most Americans are poorer, and most businesses shakier, than they would be without government central banking, high spending, and regulations.