There appears to be an inherent tension within the U.S. Federal Reserve Bank’s (Fed) dual mandate of price stability and full employment. Some inflation hawks make the case that the economy would be better served if the Fed would simply focus on containing the threat of high inflation.
Currently, the continued low interest rate environment is conducive to relatively greater economic growth as firms, theoretically at least, can borrow at a lower rate in order to expand their businesses. Ideally, as businesses continue to grow, the nation’s employment outlook improves. However, the longer that the Fed holds off on raising targeted short-term interest rates, the greater the risk of a sustained period of high inflation.
In light of this critical trade-off, it is easy to imagine the political pressures exerted upon the Fed’s decision-making committee, the Federal Reserve Board. The Fed’s dual mandate requires the Federal Reserve Board to craft monetary policy with a multitude of stakeholders in mind. For those in Washington D. C. who have a decided bias towards higher economic growth in the more immediate future, the desire is for the Fed to continue on the current course of easy money. On the other side of the fence are consumers, who may be more concerned with the rising costs of food, gas and other necessities.
A good example of Fed policy adversely impacting the overall economy is the housing bubble of the last decade. From the middle of 2003 into the middle of 2004, the Fed held the federal funds rate at 1.00%, slowly and incrementally raising it. This is an extraordinarily low rate given the length and magnitude of the recovery following the 2001 recession. Many believe that by holding interest rates abnormally low (presumably in order to prompt greater economic growth) the Fed provided excessive incentive to borrowers, which in turn drove up home prices to unsustainable levels. The widespread economic problems caused by the housing bubble have been well documented.
In contrast to the Fed’s dual mandate, the European Central Bank (ECB) has a single mandate of maintaining price stability. This week the ECB began to raise short-term interest rates in order to get ahead of inflationary pressures despite high unemployment in the European Union. Considering the problems that the Fed can cause by seeking to boost employment with artificially low interest rates, perhaps it would be appropriate for Congress and the President to require the Fed, like the European Central Bank, to focus solely on targeting an acceptable range for future inflation.
For further information, please contact Pat Fisher.
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