By Gavekal Capital Blog. Originally published at ValueWalk.
To no one’s surprise, the Federal Reserve left the Federal Funds target rate unchanged at 25 basis points, exactly where it has been since December 16, 2008.
The amazing length of time the Fed has left rates so low poses the question –
Does the Fed have a bias for one party? And, what does that mean?
Federal Funds Rate by U.S. President
Here’s a look at the target Federal Funds rate by U.S. president.
The horizontal axis is the number of days the president has been in office.
The vertical axis is the smoothed Federal Funds rate.
Each colored line represents a U.S. president.
The chart shows some well-known choppiness.
The Fed hiked rates during Carter’s Administration to head off inflation, left rates relatively stable during Clinton’s Administration, and has never hiked the rate during Obama’s Administration.
(As a side note, if Obama manages to make it another year and a half without a rate hike, he will be the first U.S. president to have never experienced a Fed rate hike.)
In looking at the detail, it’s difficult to make out if there’s any bias for one party or another. A better way to inspect for bias is probably a boxplot, presented shortly.
Is There a Bias? And, If So, By How Much is the Bias?
In order to see whether there’s any preference coming from the Federal Reserve, here’s one way to inspect for such a bias.
The graphic is a boxplot of the Federal Funds rate by party.
Interestingly, on average (really it’s on the median, although people say on average), the Fed gives Democrats rates that are 2% lower than Republicans. That amounts to about a 33% discount.
With some interesting visual evidence, it might be worth doing some econometrics for further inspection.
Boxplot
Doing Some Statistics
With the visual look established, one way to check for bias is to run a regression.
Here’s a simple linear regression (the regressions can get much more complex, including ARIMA, GARCH, VAR, and others).
In the following regression, the unemployment rate is the unemployment rate, the CPIYY is the year-over-year change in the CPI, the SP500 is the S&P 500, and Party1 is the party in power. Party1 equals 1 when the party in power is Democratic and 0 if the party in power is Republican.
Interestingly, in the linear version, the visual results given above are confirmed, although to a lesser degree.
The -.56 coefficient on Party1 indicates that when a Democrat is in the Oval Office, the Fed generally has a lower Federal Funds rate by a little over half of a percent. That’s after accounting for the other variables observers typically think the Fed is considering, including the unemployment rate, the inflation rate, and the value of equity market.
So, there’s certainly a correlation.
The fascinating result means something beyond simple bias (ignoring, for the moment, the endless debate that correlation doesn’t mean causation).
A lower Federal Funds rate equates to jobs and economic growth.
Without going to much into potential figures, the Fed bias might equates to 1 or 2 million jobs over the course of 8 years.
That’s a chunk of bias.
The Fed: Conclusion
Perhaps unsurprisingly to observers of the politics behind the Fed, the Fed has a general bias towards the Democratic Party.
The amount of the bias may be around 2% if one uses the simple average of the Fed Funds rate by party.
In doing some econometrics on the bias, the actual bias might be more like 1.5%.
What does the bias mean in terms of jobs or GDP?
In terms of jobs, the bias may mean that the Fed attempts to create 1 or 2 million more jobs during Democratic Administrations compared to Republican Administrations.
So, there’s a bias that equates to something material.
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