Eliminating the Dual Mandate
In the one hundred years of the Federal Reserve System's existence, the Unites States economy has endured significant turmoil with the Great Depression, stagflation in the 1970s, and the recent financial crisis. Simultaneously, the discipline of macroeconomics has been constantly evolving, reacting to these unprecedented challenges by reevaluating previous models and developing new ones. Since the Humphrey-Hawkins Act of 1978, the Fed has been legally obligated "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" through appropriate monetary policy (qtd. in Schwartz and Walker 179). Economists refer to this as the "dual mandate" (Schwartz and Walker 178), specifying maximum employment and stable prices, as moderate long-term interest rates generally follow price stability. However, considering the fundamental limitations of monetary policy and the current justifications for unconventional action, the Federal Reserve should eliminate its dual mandate and instead concentrate solely on maintaining price stability.
The Federal Reserve should not be required to promote maximum employment because monetary policy cannot directly reduce the level of unemployment in the long run. The notion that the Fed could control unemployment was extrapolated from A.W. Phillips' observation of a historically inverse relationship between inflation and unemployment, known as the Phillips curve. It was widely believed that there was consequently a tradeoff between the two, resulting in policymakers allowing inflation to rise in the 1960s and early 1970s (Bernanke). This assertion is fallacious, however, as money is neutral in the long run, producing only nominal changes (Schwartz and Walker 178), though there is evidence of a regional Phillips curve tradeoff (Fitzgerald, Holtemeyer, and Nicolini). Because prices are "sticky," or inelastic, in the short run, an increase in the money supply through open-market operations will temporarily increase economic growth; in the long run, however, prices are flexible and will eventually adjust to a higher equilibrium (Fortunato and Strader). The resulting level of unemployment, termed the "natural rate of unemployment," "depends on 'real ' as opposed to monetary factors," such as the quality of human capital and the population's entrepreneurial capacity (Friedman) . Unfortunately, "adding zeros to the money supply and prices is all that will be achieved by an overly expansive Fed" (Schwartz and Walker, 178). While economists perceive no long-term employment benefits from expansionary monetary policy, price stability is another matter.
Former Fed chairman Ben Bernanke believes there is a consensus among policymakers and economists that price stability reduces unemployment levels and variability through positive economic growth. He claims this has been demonstrated by the Great Moderation, a period of low economic volatility from the mid-1980s to the recent financial crisis. "The key to explaining why price stability promotes stability in both output and employment is the realization that, when inflation itself is well-controlled, then the public's expectations of inflation will also be low and stable" (Bernanke). Yet this influence on unemployment is an indirect result of price stability. Unemployment cannot be directly impacted by monetary policy; nevertheless, its place in the dual mandate is cited as justification for unconventional action.
Critics of the dual mandate often reference the Fed disastrously increasing money growth in the 1970s as a primary example of why the goal of maximizing employment should be removed (Taylor). However, this was caused by unknowingly false Phillips curve analysis; thus, a recent response to the Great Recession provides a much more pertinent example. After the Fed reached the zero-bound of the federal funds rate in 2008, it began conducting an unconventional policy of large-scale asset purchases known as "quantitative easing" with the explicit intent of increasing inflation and maximizing employment (Labonte 15). QE is controversial because it affects long-term interest rates, an uncharted territory for a system of bond transactions that traditionally impacts the short run. Even a former Fed official who worked on the program stated, "The potential for the Fed to distort the financial markets and the overall U .S. economy... is unprecedented and immense" (Huszar).
Opponents of eliminating the Fed's dual mandate have argued that QE would have been implemented regardless of a concern over unemployment, as the purchases were also an attempt to increase inflation for price stability (Taylor). However, historical analysis from the Federal Reserve Bank of St. Louis suggests differently. Recent press releases by the Fed have increasingly referenced the objective of maximum employment, even though past unemployment rates have been similarly high but never mentioned (Thornton 2). This represented a "significant shift in language" (Taylor). Moreover, QE ran a substantial risk of creating high inflation by increasing the monetary base, although currently banks have been holding the funds as excess reserves (Fortunato and Strader). Thus, the evidence strongly implies that QE was consequence of the Fed attempting to maximize employment, further supporting the contention that the dual mandate should be eliminated.
For over three decades the Fed has operated under the dual objectives of stable prices and maximum employment. Price stability has historically proven to be "both an end and a means to monetary policy" (Bernanke). However, especially accounting for recent "extraordinary discretionary actions" (Taylor), monetary policy looking to ameliorate unemployment levels has been demonstrated to be not only impossible directly, but dangerous for the U.S. economy. Therefore, the Federal Reserve should replace its current mandate with an exclusive focus on price stability, elucidating the purpose of the system and initiating a century of responsible monetary policy and consistent economic growth.