The Fed's Bipolar Mandate
Time to repeal the Humphrey-Hawkins Act of 1978..
Wall Street Journal editorial
To be specific, Paul Ryan suddenly has company. The Wisconsin Congressman has since 1999 proposed legislation that would let the Fed focus monetary policy solely on the goal of stable prices. This week he's been joined by fellow Republicans Mike Pence of Indiana and Tom Price of Georgia, while Senator Bob Corker of Tennessee told us he plans to work with Mr. Ryan to introduce legislation next year that would lift the dual mandate. If the 112th Congress did nothing else, this would be worth the price of its election and a major contribution to better economic policy.
These columns have decried the dual mandate since it became the law of the land in 1978 with the Full Employment and Balanced Growth Act, aka Humphrey-Hawkins. To appreciate the problem, consider that in the original Federal Reserve Act of 1913 Congress asked the central bank to supervise banks. It did not mention explicit economic goals. Even in the Keynesian heyday of the Employment Act of 1946, Congress did not ask the Fed to manage the economy.
But with Humphrey-Hawkins, Congress ordered the central bank to "promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates." The political context in that age of Jimmy Carter will sound familiar. U.S. unemployment was stubbornly high and the fiscal policies (tax rebates) of a Democratic Congress had failed to stimulate. So the politicians decided to conscript the Fed in its job creation mission by ordering the ostensibly independent central bank to target employment as well as prices.
The contradictions were as apparent then as now; as Mr. Corker puts it, a central bank cannot have "a bipolar mandate." The pressure to bring down unemployment using money creation during difficult economic times will inevitably complicate the task of maintaining stable prices. As the Fed pushes money out the door, whether or not there is an economic demand for more dollars, there will be an illusion in the short-run that people are better off. But the longer-term effect may be inflationary as too much money chases too few goods.
The U.S. spent the end of the 1970s and early 1980s digging out of the mess created by the Fed's effort to boost job creation by printing money. That experience was also seared into the minds of the founders of the European Central Bank who in 1998 explicitly rejected the dual mandate in favor of a single goal of price stability. The ECB has performed far better than the Fed over the last decade by following that single lodestar.
Over time, the Fed has internalized the dual mandate to such a degree that it is now built into its economic models. This takes the form of the "output gap," which posits that inflation can't rise as long as there is unused capacity in the economy. One measure of the output gap is high unemployment. The output gap model led the Fed astray in the last decade, persuading Alan Greenspan and Ben Bernanke to keep interest rates too low for too long even as commodity and housing prices soared and the dollar fell.
Now the dual mandate is being used again to justify the latest round of "quantitative easing." New York Fed President William Dudley has referred explicitly to the high jobless rate as one justification for QE2.
The larger problem with the dual mandate is that it inevitably makes the Fed a political actor. Fed governors are forced to pretend they can be economic saviors, able to rescue workers and business from the consequences of failed fiscal and regulatory policies. This is precisely what the Fed is being asked to do today, using QE2 to save the Obama Administration from a 9.6% jobless rate despite trillions spent on economic stimulus, foreclosure mitigation and cash for clunkers. Mr. Bernanke has too often made the Fed appear to be an agent of the Treasury, as he did again yesterday in Frankfurt by blaming China's pegged currency for U.S. economic ills.
The irony is that critics of QE2 are being portrayed as enemies of Fed independence, when the truth is the opposite. Ending the dual mandate would liberate the central bank to focus on the single task of stable prices, which is hard enough in a world of fiat money and no formal price rule. Mr. Greenspan once understood this and urged Congress to repeal Humphrey-Hawkins.
We're told Mr. Bernanke has also expressed this desire in private. With monetary policy and the fate of the dollar back at the forefront of public debate, the next Congress can do a service by repealing the damage done in 1978.