Federal Reserve Board (Fed) Chairman Jay Powell recently announced a new policy framework within which to achieve its long-accepted goals of full employment with low and stable inflation. This change created some disruptive uncertainty in financial markets about how the Fed will behave in the future. Today’s level of disruption and uncertainty would pale, however, if certain elements in Congress succeed in forcing on the Fed a number of additional objectives, what the Fed calls “mandates,” prominent among them enlisting the central bank to fight global warming or to erase wealth differences among society’s different demographic groups.
Two significant dangers attach themselves to such a push for additional Fed objectives:
- Additional mandates would inevitably contradict each other. Since the promoters of these new Fed objectives would surely leave the Fed no guidance about priorities, monetary policy will become less predictable and more volatile. The resulting confusion in the economy would undermine the effectiveness of monetary policy, however directed, and bring on greater volatility in financial as well as labor markets. When people cannot plan, they neither invest nor hire as aggressively as otherwise.
- The Fed simply lacks the tools to pursue these new objectives, inviting monetary policy makers to overwork the blunt tools they have at their disposal or reach for new powers that would create a more centrally directed economy than the United States has today and one less effective in innovating and meeting the needs of its people. To see the depth of these problems, take a look at the likely Fed response to two of these proposed new mandates.
There is, for one, the matter of global warming. The only policy levers the Fed presently has at its disposal are its regulatory powers and its ability to encourage or discourage greater levels of economic activity by decreasing or increasing interest rates and so the amounts of liquidity in financial markets. Policy makers might decide that higher levels of economic activity tend to increase levels of carbon in the atmosphere and so restrain growth in order to stem the global warming trend. But such a measure would contradict the Fed’s other mandate to pursue full employment. However the policy makers decided, the Fed would face the prospect of being dragged before Congress and accused of failing one way or another. Alternatively, the Fed could use monetary policy to pursue full employment while at the same time asking for greater latitude in its regulatory brief to force banks to, for example, lend on favorable terms to “green” ventures. But, as became apparent during the financial crisis of 2008-2009 when regulators (though in that case not the Fed) pressed lenders to extend loans to less-than-credit-worthy homebuyers, such regulatory enlargements contradicted the critical regulatory goal of securing stability in the financial system.
The Fed would find itself in a comparably impossible situation with an added mandate to equalize incomes across different demographic groups. An aggressive effort to stimulate economic activity might increase incomes, but it would also contradict the Fed’s need to maintain low, stable rates of inflation. It might not even help ease income inequality. A general rise in wages and salaries might benefit people at the bottom of the income distribution, but it could benefit others equally or more, widening income inequality. Were the Fed to seek new regulatory tools to accomplish its additional goal, say by pressuring banks on lending decisions or businesses on hiring or wage decisions, it would invite the same sorts of problems that happened with housing in 2008-2009.
Expanding Fed power to pursue new mandates presents another more fundamental danger. It would move the United States in the direction of a command economy. That flies in the face of practices followed since the country’s founding. A movement toward a command economy would also render it less effective and less innovative. One reason the U.S. economy has managed to grow so prosperous and innovative is that its decentralized approach to decision-making has led it to try many different directions simultaneously. Many of these efforts fail, but because each individual effort reflects a small part of the economy, those that succeed in meeting widespread needs, and consequently grow significant, pay off so handsomely that they more than overcome the economic drag of the failures. When decisions are centrally directed, mistakes occur on a vast scale, as the nation discovered with the housing push that culminated in the 2008-2009 financial crisis. Then, the nation has to live with the huge waste for years.
Those in Congress who would force additional mandates on the Fed seldom seem to think of the contradictions and ills they would cause. They see worthy causes and that is as far as their thinking goes. That is a mistake. However otherwise desirable these objectives are, the Fed is clearly not the place to pursue them. Still the politics remains viable, even as the economics is doomed to failure. So far these elements have not made much headway, but, as should be clear, their continuing efforts remain a significant risk.