Update 395 — Fed Chair Powell Hits the Hill:
Is it Time for a Third Mandate for the Fed?
Fed Chair Jerome Powell testifies this week before the Joint Economic and House Budget Committees to discuss the overall economic outlook. His appearances give members of Congress the opportunity to ask what could and should the Fed do to address a broad and fast-growing structural issue bedeviling the economy — inequality.
What can and should the Fed do to avoid or mitigate the economic depredations of inequality or to stem the problem itself? Some in Congress believe the Fed responsible for the general welfare and able to guarantee it. The truth is not so simple but Congress could fix that by expanding the Fed’s mandate or adding a third one. Or could it?
At the end of October, the Fed cut rates for the third straight time since raising rates last December, setting the federal funds rate now between 1.5 and 1.75 percent. Fed Chair Powell indicated that this could well be the last such “mid-cycle adjustment” rate cut in 2019.
While some applaud the benefits of rate cuts on short-term borrowing for low-income families (net debtors), others point to the effect of low interest rates on speculation and asset price inflation.
The Fed is pursuing its dual statutory mandate of price stability and maximum employment. Inflation is under the Fed’s two percent target and has been for several years. The official unemployment rate is the lowest in 50 years. Nevertheless, poverty is on the rise and the country is suffering the highest levels of income inequality in 50 years, per the Census Bureau.
History of the Fed Dual Mandate
Prior to the Federal Reserve’s creation in 1913, the U.S. economy experienced several panics, bank failures, and credit scarcity. The U.S. central bank pursued one monetary policy goal upon establishment: price stability.
The full employment movement began in the wake of the Great Depression, before the wartime boom of the 1940s. The call grew louder after World War II, as blacks and women — new entries to the wage-earning workforce during the war — rallied to keep their jobs.
The Employment Act of 1946 mandated federal government agencies to pursue full employment, but did not give the Fed the explicit mandate until rising inflation and unemployment in the early 1970s provoked fears of another major recession. Civil rights leaders, seeing the effects of stagflation on marginalized workers and their families, joined the fight for full employment.
After years of concerned citizen-leaders lobbying Washington, Congress passed the 1978 Full Employment and Balanced Growth Act (Humphrey-Hawkins), which instituted a second Fed mandate: maximizing employment. From then until now, maintaining price stability and maximizing employment is known as the Fed’s dual mandate.
The Fed’s mandate to maximize unemployment relies on the concept of the natural rate of unemployment, and the relationship between inflation and employment known as the Phillips Curve. This linkage has come into question in recent years, as persistently low unemployment (numbers well below what was conventionally considered the natural rate of unemployment) has not had any noticeable effect on inflation. As conventional economic wisdom changes, so should policy making.
A Third Mandate
The roles and responsibilities of the Federal Reserve have grown over time, from pure price stabilization, to full employment, to regulation of the banking sector. In a time of unparalleled income and wealth inequality, and central banks’ potential role in exacerbating this divide, some members of Congress have asked the Fed to mitigate income/wealth inequality. Would it take a third mandate to enable the Fed to address macroeconomic performance problems arising from inequality? Would such a mandate make a difference?
The Fed’s pursuit of historically low interest rates coupled with large-scale asset purchases in the form of quantitative easing exacerbated income and wealth inequality after the 2008 financial crisis. The two monetary policy tools had the effect of artificially inflating stock market prices and allowing for more and more cheap leverage, particularly in the corporate sector. On the one hand, loose monetary policy can increase employment and tighten labor markets, but it is just as likely to inflate asset prices and fuel a corporate debt bubble. Subsequent bailouts would put the American taxpayer on the hook.
Progressive members of Congress cheering on Fed rate cuts for their constituents should consider a third Fed mandate to directly address economic inequality. Without such a mandate, interest rate, and other monetary policy decisions, are made in ways that could potentially worsen or have a minimal impact on the lower-income constituents they serve.
By creating a third mandate, the Fed would think twice before making monetary policy decisions. For example, there are ways that large-scale asset purchases by the Fed could be conducted more progressively, primarily by varying the kind of assets that the Fed purchases. Each should be evaluated from the perspective of their result on income/wealth heterogeneity. On interest rate decisions, the Fed would have to more thoughtfully consider the distributive effects of low interest rates on skewing wealth and income to the top of the curve.
Fiscal policy must remain the primary means of addressing the structural problem of economic inequality, but there is no denying that monetary policy has indirect effects on distribution. To what degree and to what ends is unclear, but without an economic equality mandate, the Fed will make decisions irrespective of the distributive effects.