In 1977, Congress first gave the Federal Reserve a dual mandate to promote both “maximum employment” and “stable prices.” At the Republican presidential debate on Sept. 12, the major candidates argued that the Fed should instead focus squarely on the goal of long-run price stability.
Responding to a question about the Fed, Rick Santorum said: “make it a single charter instead of a dual charter” institution, and no candidate disagreed. Most piled on. “Its focus needs to be narrowed,” said Herman Cain. “We need to have a Fed that is working towards sound monetary policy,” said Rick Perry. “The Federal Reserve has a responsibility to preserve the value of our currency,” said Mitt Romney.
Some worry that a single focus on the goal of price stability would lead to more unemployment. But history shows just the opposite. A single mandate wouldn't stop the Fed from providing liquidity, or serving as lender of last resort, or reducing the interest rate in a financial crisis or a recession. But it would make it more difficult for the Fed to engage in the kinds of discretionary actions that frequently have resulted in higher unemployment.
Several times in the 1970s the Fed increased money growth, trying to reduce unemployment. But the unintended consequence was actually to increase joblessness: Higher and higher inflation rates eventually required a painful disinflation, with unemployment rising above 10 percent. From 2003 to 2005, the Fed kept interest rates extra low, partly out of concern about employment. But those extra-low rates exacerbated the housing boom, leading to a bust -- a big factor in the financial crisis that eventually caused a devastating increase in unemployment.
By contrast, for most of the 1980s and 1990s -- starting when Paul Volcker became chairman -- the Fed stressed the goal of price stability in its actions. The result was much lower unemployment than before or since.
The dual mandate language is based on an outmoded concept of a tradeoff between inflation and unemployment. Moreover, too many goals blur responsibility and accountability. The dual goal enables politicians to lean on the Fed, and people often cite it as an excuse for unconventional policies.
Indeed, one of the reasons for the growing interest in removing the dual mandate is the extraordinary discretionary actions the Fed has taken in the past few years -- including large-scale purchases of mortgage-backed securities and longer-term Treasuries, a strategy commonly called "quantitative easing."
The Fed has explicitly used the dual mandate to justify these unusual interventions. During the 1980s and 1990s, Fed officials rarely referred to the dual mandate (even in the early 1980s, with unemployment rates as high as today). When they did so, it was to make the point that achieving price stability was the surest way for monetary policy to keep unemployment down.
Research by Daniel Thornton of the Federal Reserve Bank of St. Louis establishes these differences. Thornton traced references to the dual mandate in the written releases of the Federal Open Market Committee and documented a historically significant shift in its language. Until very recently, policy statements and directives from the Fed didn't explicitly mention the “maximum employment” part of the dual mandate in the Federal Reserve Act. The committee's members preferred to emphasize the goal of price stability and its role in creating strong economic and employment growth.
In fact, Thornton found no references to “maximum employment” in the Fed's written directives and statements from 1979, when Paul Volcker took over as Fed chair, until the end of 2008, just as the Fed was embarking on its first large-scale asset-purchase program, now known as QE1. It increased its references to maximum employment in the fall of 2010 as it embarked on QE2.
Some argue that a single mandate wouldn't have prevented the recent trend toward highly discretionary monetary policy. Professor Greg Mankiw of Harvard University argues that "If the Fed's mandate were different, monetary policy today might well be the same. That is, with inflation now below its target, the Fed could be pursuing QE2 even if it were operating under the proposed mono mandate."
But Thorton’s careful historical research suggests otherwise.
(John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution.)
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John B. Taylor at email@example.com