By Robert Gavin
Boston Globe Staff
July 1, 2004

With the presidential election coming soon, that can mean only one thing: The Federal Reserve is messing with interest rates.

History shows that the Fed will raise or lower its key federal funds rate regardless of which party holds the White House. In recent elections, the first President George Bush, President Ronald Reagan, and President Jimmy Carter all watched as the Fed raised or lowered interest rates in the months before each was seeking a second term. Only Reagan won.

In 1992, with both the economy and his reelection campaign struggling, Bush criticized the Fed for not cutting rates far or fast enough, and Bush loyalists later blamed his defeat, in part, on Fed policy, which they believed held back the recovery by keeping rates too high for too long.

Now, with the second President Bush seeking reelection, few analysts expect the Fed to become an issue. The main reason: economic conditions are dramatically different.

Unlike the election year of 1992, the economy has clearly turned the corner. It has added nearly 1 million jobs over the past three months, and should only improve in the run-up to the election, many economists said. The Fed now has to begin raising interest rates to prevent the economy from growing too fast and fueling inflation, they said.

With inflation still tame, economists add, the Fed can gradually raise interest rates so as not to derail the recovering economy and labor market. Even with yesterday's quarter-point boost, to 1.25 percent, the key Fed rate remains near historic lows. Economists say the likely increases to follow should only put the rate at a still historically low 2 percent by the end of the year.

''Clearly, the economy has a very good head of steam and it's going to take a lot more than that to slow it down," said Nariman Behravesh, chief economist at Global Insight, the Waltham consulting firm. ''Given the strength of the economy I don't think the Fed is going to come under much criticism."

Economists expect at least one more quarter point increase in the federal funds rate before the November election. The federal funds rate, set by the Fed, is the interest banks charge each other for overnight loans and is the foundation for other consumer and business loan rates. Though interest rates rise immediately after the Fed raises the Fed funds rate, it typically takes about a year for those changes to affect the economy.

The Fed is an independent agency largely insulated from partisan politics, but its policy makers are nonetheless sensitive to perceptions that their interest rate actions -- or lack of them -- are designed to influence the outcome of the election, economists said. If they had their choice, policy makers would probably prefer to sit pat until after November, according to the legions of Fed watchers.

Often it hasn't worked out that way. For example, in 1980, with the economy wracked by runaway inflation, the Fed started raising the key federal funds rate in August, doubling it to 19 percent by year's end from 9.5 percent. That sent mortgage and other rates soaring, and President Carter lost his reelection bid to Reagan.

''I don't think this Fed will be swayed by the election, and no one following the election will focus on their tightening roles," said Mark Zandi, chief economist at Economy.com, a West Chester, Pa., consulting firm. ''It's too late in the game. A rate hike today is not going to have a measurable effect on economy by the election."

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