By Howard Wei
The Federal Reserve Bank of the United States has two stated goals, termed the dual mandate. The first is to ensure that the economy maintains the maximum rate of natural employment. The second is to ensure stable prices in the economy.
In accordance with its dual mandate, early November of 2010, the Federal Reserve announced the implementation of a second round of large scale asset purchases, LSAP, in hopes of expanding the economy. The Fed claimed that they would buy $600 billion in long-term Treasuries in the coming months, while also reinvesting an additional $250 billion to $300 billion in Treasuries with the proceeds of earlier investments. One of the main criticisms of such a policy was that there was a risk of uncontrollable inflation because the policy severely decreased the value of money. However, at this time, the Fed viewed that ensuring maximum employment was a more important goal than stable prices. For some time, the economy had been flat, with no discernable growth, and there was even a possibility of deflationary pressures.
Discussion of changing the Federal Reserve’s dual mandate into a single mandate has occurred for quite some time. However, recently, there has been a growing trend in Republicans to restrict the Fed’s mandate. Congressmen hope to introduce legislation limiting the dual mandate to only the mandate to price stability. Representative Kevin Brady Vice Chairman told a hearing of Congress’s Joint Economic Committee that restricting the Fed’s mandate to price stability would not mean the issue of employment would be ignored. In addition the legislation would require the Federal Reserve to publicly announce an inflation target. Similar sentiments from other members of the Republican Party stem from the fact that US economic recovery remains fragile, and unemployment has remained above 9 percent.
In this article, I contend that the use of a single mandate is detrimental to the efficiency and efficacy of the central bank, and that a single mandate of price stability is especially detrimental to economic growth in the United States.
Politicians have cited many reasons for a single mandate. First and foremost is that by adopting a single mandate, the Fed can focus on a single goal and set up a clear framework to achieve that goal. Kevin Brady told a hearing of Congress’s Joint Economic Committee that restricting the Fed’s mandate to price stability would not mean the issue of employment would be ignored. But by limiting the Fed to only a single mandate, the justifications for monetary policy are severely decreased. An action taken by the Fed would have to be warranted by some effect towards price stability. Even if the Fed keeps an eye on employment, methods of aiding that aspect of society is hard if the Fed only has one stated goal. Further, a working paper published by the IMF claimed that deflation generally does not occur when there is a large output gap. Thus, by solely concentrating on a single mandate, other aspects of the economy can easily be overlooked, such as the output level of the economy.
In addition, price stability and unemployment are inevitably locked concepts. When monetary policy affects price stability, effects will be found in employment levels. For example, when the Fed decreases interest rates, generally, prices would rise, and unemployment would fall. Restricting to only a single mandate would disregard this obvious relationship, making monetary policy all the more difficult to implement. Those advocating for the single mandate cite this as a reason for the single mandate, as the central bank should not focus on two cross purposes, and thus only focus on price stability since the bank can directly control inflation. However, just because employment is trickier to deal with, because there may be other variables that affect the unemployment rate, that is not a coherent reason to disregard it as a goal. The bank should strive to best achieve the goal of maximum employment, because it ensures a better economy holistically. The inability to accurately perceive an outcome is not a reason to not consider that outcome. The mindset of this justification thus implies that employment is only secondary to price stability, when the opposite situation may be true.
Further, a move for the single mandate in the current economic situation is especially harmful to economic policy. The instability of the economy could produce widely undesirable effects if the environment of economic policy is changed. Although economic conditions have not improved since the implementation of LSAP, the movements of Congress do not help the cause. While the Fed has imposed expansionary monetary policy, Congress has implemented a detrimental contractionary fiscal policy. On October 4, in a testimony before Congress, Ben Bernanke emphasized that the Fed is already acting aggressively to support growth, but that the Fed alone cannot fully recover the situation. Fiscal policy makers are acting in opposition to monetary policy, as Bernanke elaborates, “state and local governments continue to tighten their belts by cutting spending and employment in the face of ongoing budgetary pressures.”
The reason for the movement for a single mandate is already flawed in their motivation. As Congress attempts to place the blame for poor economic recovery on non political institutions, the root problem of economic recovery cannot be solved. Politicians inevitably must please their constituents, so cannot always focus on economic policy. While the economy is in a downturn, expansionary policy is needed. However, to those who already have a hard time paying mortgages or finding jobs, hearing that the government is increasing spending only incites anger and frustration. Therefore, the Federal Reserve plays a unique role in that it is widely unaffected by such pressures, and can implement the policies needed to improve the economy. Limiting this institution in its mandate will only limit its powers, making economic regulation an even harder task.
The recent movement in Congress to change the Fed’s dual mandate to a single mandate of price stability has been misconceived from the start. The anemic economy cannot be blamed solely on the Federal Reserve, and limiting its powers can only mean greater harm to the economy.
1 Lisa Lambert “Republicans Question Federal Reserve’s Dual Mandate” Reuters. Oct 4, 2011 .
2 Andre Meier “Still Minding the Gap – Inflation Dynamics during episodes of Persistent Large Output Gaps.” IMF Working Paper. August 2010 .
3 Mark Thoma “Bernanke: Fiscal Policy is of Critical Importance” CBS Moneywatch. October 4, 2011 .
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