The Fed’s Quadral Mandate and Impossible Balancing Act
The Fed’s responsibilities keep expanding. A 1977 update to the Federal Reserve Act included the goals of “maximum employment” and “stable prices”. Many economists, even in the mainstream, criticize this dual mandate as a difficult, if not impossible, balance. They point to Short-run Phillips Curves that show a tradeoff between inflation and unemployment rates. Expansionary monetary policy may encourage employment, but it runs the risk of above-target inflation. Contractionary monetary policy may rein in inflation, but at the detriment of employment levels.
A quick glance at any measure of prices or employment over the history of the Federal Reserve shows a complete failure to satisfy either half of their dual mandate, much less the whole.
During the most recent recession, the Bernanke Fed took on more responsibility: pacifying financial markets. In later remarks, he said that any central bank has two responsibilities: economic stability and financial stability. Bernanke considers maintaining maximum employment and stable prices as two parts of the economic stability responsibility. He details the difference in some 2012 lectures at George Washington University:
“For financial stability, the main tool the central banks have is lender of last resort powers by providing short-term liquidity to financial institutions, replacing lost funding. Central banks as they have for, you know, number of centuries, can help calm a financial panic. For economic stability, the principal tool is monetary policy, of course in normal times, that involves adjusting the level of short-term interest rates.”
The Fed has also taken on global economic and financial stability in recent years. At the recent World Bank and IMF meeting in Peru, China’s finance minister said that the US central bank “should assume global responsibilities” and hold off on raising interest rates to promote more demand from developed countries for output from developing countries.
The image of seesaws on top of seesaws comes to mind when I consider the Fed’s balancing act. The dual mandate is now a quadral mandate: maximum employment in the US, stable prices in the US, financial stability in the US, and, laughably, global economic growth. Astonishingly, their purview and responsibilities expand even when they have proven themselves totally incapable in accomplishing their original goals.