Sink the Fed’s dual mandate and QE2

November 18, 2010

Multitasking is hard, even for the Federal Reserve. But by law — yet another horrible policy relic of the 1970s – it has to promote both “maximum employment” and “stable prices.” Some Republicans think it better that the Fed, like its European Central Bank counterpart, focus solely on prices getting neither too hot nor too cold. And an effort by Representative Mike Pence of Indiana and Senator Bob Corker of Tennessee is just the start of a GOP push to roll back Team Bernanke’s vast authority.

A just-offered bill by Pence would simply strike the bit about jobs from the Federal Reserve Act. The casus belli is part procedural, part economic. Corker and Pence say the Fed’s attempt to boost the economy by buying bonds usurps the proper fiscal role of Congress and the president. It also risks devaluing the dollar and boosting inflation.

The political context is clear. The opaque, unelected Fed is wildly unpopular with Republicans, particularly those of the Tea Party variety. They blame its interest rate policy for the housing and bank busts. And Bernanke is seen as an enabler of the hated bank bailouts and explosion in government spending under President Barack Obama. Tea Party support would be helpful to Pence if he decides to run for higher office, as he is supposedly considering.

Corker, on the other hand, is just trying to keep his current job. His efforts to forge a compromise with Democrats on financial reform made him enemies on the right where some folks already doubted his conservative bona fides. So clipping the Fed might just help him avoid a Tea Party primary challenge if he runs for reelection in 2012.

But the gentlemen also know the effort makes for sound economics. The existence of the dual mandate is a big reason why the Fed has launched its bond-buying QE2 plan, a triple-bank shot effort to artificially boost jobs by lowering interest rates,  weakening  the dollar (and boosting exports) and lifting stocks (and creating a wealth effect). Now the Fed knows QE2 will make it that much tougher to eventually shrink its balance sheet — thus risking higher inflation —  but feels it has no choice since Congress and the president are unlikely to agree on new, pro-growth fiscal policies. Of course, Fed action also eases the pressure on Washington to act. So instead of cutting taxes to empower business and allow consumer to repair their personal balance sheets, the Fed’s bubble machine gets restarted.

A Republican would have to nab the presidency that year for the Corker-Pence idea to become law. Democrats love the dual mandate and wish the Fed were doing even more to boost jobs. They expanded the Fed’s mandate in 1978 as a way of forcing the central bank to print money. But thankfully things have not worked out that way. The 1980s combo of hard-money Paul Volcker and tax-cutting Ronald Reagan created a low-inflation, high-growth economy that has produced 50 million net new jobs during the past generation.

But the dual mandate gives ample authority and justification for an easy-money Fed chairman to run the presses, particularly is he’s under political pressure to do so. Now Democrats may argue that a mandate change would tie the Fed’s hands in a financial crisis. A Fed chief could easily cite price stability as justification for setting up lending facilities as Bernanke did in 2008 and 2009. After all, U.S. prices fell sharply during the worst of the 2008 downturn. Indeed, one possible future GOP pick to run the Fed doubts whether such rule would limit his policy actions. If Republicans take the White House in two years, he just may find out.

2 comments

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Well argued, James.

Here in the True North the Bank of Canada’s sole responsibility is to ensure core inflation remains in a band between 1% and 3%, averaging 2% over time. The Bank has zero responsibility for job-creation or, more accurately, setting up the conditions conducive to job creation and economic growth. That’s the purview of politicians. And that means they can’t pass the buck, as Mr. Obama has done.

It’s not a perfect system, but over the past nearly twenty years that the Bank has had this tightly focused mandate, Canada has managed to emerge from being a debt-ridden, near third-world country to one that has, to a degree, managed to ride out this economic crisis quite well. Clearly there was some luck involved, but Canada’s inflation-targeting central bank coupled with just one agency regulating the country’s financial institutions may provide some lessons for America.

Posted by Gotthardbahn | Report as abusive

While you make some valid points, there are a couple of statements that are incorrect.

While many republicans do agree with the majority of the Tea Party ideals, ie smaller government, lower taxes, the ones that have even the slightest clue about world financial markets do not hate the Fed. In fact, they understand its crucial role in the world economy. To go even further, those with economics and finance degrees understood the importance of bailing out the banks during the crisis.

The other problem with the editorial is the mention of inflation. Where is it? It doesn’t exist. Energy and fuel prices may have ticked up a bit but you should know that they are volatile components of the pricing indexes. Inflation isn’t a real concern until the slack, unemployment and excess industrial capacity, are taken out of the system. We know that is a long way off.

Posted by Upstate184 | Report as abusive