The Federal Reserve’s mandate has become a source of growing confusion and debate among economists and policymakers. While commonly referred to as having a “dual mandate” of maintaining full employment and price stability, the central bank actually operates under a three-part directive established by the Federal Reserve Reform Act of 1977, which includes the additional responsibility of maintaining moderate long-term interest rates.
This third component of the mandate has been largely overlooked and ignored in recent decades, with policymakers generally treating it as redundant. The prevailing argument suggests that by achieving its employment and price stability goals, the Fed automatically addresses interest rate concerns. Economic theory supports this view, as interest rates fundamentally reflect capital prices determined by market forces of supply and demand for loanable funds.
However, this selective interpretation of the mandate raises significant concerns about democratic accountability. Despite sound economic reasoning behind dismissing the interest rate component, the fact remains that it is legally mandated. Substituting expert economic judgment for legislative authority undermines democratic processes.
Furthermore, the logic used to justify ignoring the interest rate mandate could equally apply to the employment mandate. Labor markets, like capital markets, function through supply and demand mechanisms. Following this reasoning, the Fed’s sole focus on price stability should theoretically be sufficient for both employment and interest rate objectives.
The inconsistency in how these different mandate components are treated suggests potential political bias rather than purely economic considerations. While any attempt to disregard the employment mandate would likely face significant pushback, the interest rate component has been quietly sidelined without similar controversy.
A solution to this dilemma would be to amend the Federal Reserve Act to narrow the Fed’s mandate to focus exclusively on price stability. This approach would align legal requirements with economic theory while respecting democratic principles. The recent experience with inflation, which approached 10 percent annually in summer 2022, demonstrates the importance of price stability and the Fed’s crucial role in maintaining it.
The timing for such reform appears particularly relevant given ongoing public concerns about inflation and high prices across various sectors. While some price increases stem from non-monetary factors, the overall price level has been significantly impacted by the Federal Reserve’s aggressive monetary response to COVID-19.
Republican lawmakers, who campaigned on addressing inflation concerns, have yet to take concrete action to refocus the Fed’s mandate. This inaction represents a missed opportunity to align the central bank’s legal obligations with its practical capabilities.
The current situation highlights a fundamental disconnect between central banking’s legal framework and its policy implementation. Resolving this inconsistency requires both statutory changes and a more consistent application of economic principles. By simplifying the Fed’s mandate to focus solely on price stability, policymakers can create a more coherent and effective framework for monetary policy.
This reform would not only clarify the Fed’s mission but also enhance its accountability and effectiveness. Rather than juggling multiple, potentially conflicting objectives, the central bank could concentrate on the critical task of maintaining stable prices – a goal that ultimately supports both employment and interest rate stability through market mechanisms.