The Economy by Peter R. Crabb: The U.S. would be better off if the Fed stuck to one goal

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaSeptember 4, 2013 

Peter R. Crabb

Most organizations, be they businesses, schools or government agencies, have a clear and well-defined goal. Not so at the Fed, and our economy remains at risk for it.

In May of this year, Federal Reserve Chairman Ben Bernanke and other members of the Federal Open Market Committee suggested the Fed would soon cut back on the $85 billion monthly purchases of government bonds and mortgage-backed securities. Since then policymakers have backtracked, suggesting there are no plans to taper off all the new money they are pumping into the banking system.

These Fed speeches created a significant amount of financial market volatility over the summer. Meanwhile, the question of who will next head up the Fed is creating additional uncertainty. Bernanke has indicated he won’t accept a new term and President Obama is being pressured to nominate a strong replacement who will help him stimulate economic growth.

With all these changes and questions, uncertainty in the markets has risen. Things would settle down if monetary policy was only about the monetary system.

The Federal Reserve Act was signed by President Woodrow Wilson 100 years ago this December. This act of Congress created the U.S. central banking system and provided legal authority for issuing Federal Reserve Notes, more widely known as dollars. The Fed’s monetary policy at that time was to maintain the stability of this new U.S. currency.

The Employment Act of 1946 added the goal “maximum employment” to the Fed’s charter. There was now a dual mandate — promote full employment while keeping prices stable. But economists knew before then and have since shown empirically that these two economic conditions often work against each other. Furthermore, there is little the Fed can do about unemployment when structural problems in our labor markets keep people out of work.

The economy fell into a recession in late 2007. By 2010 the unemployment rate in Idaho and the United States rose to 8.8 and 10 percent, respectively. If the unemployment rate rose simply because the economy went into a recession, we should be seeing more full-time work today because the economy has grown above where we started. The national and local labor market should have “cycled” back to its normal rate, around 5 percent, by now.

All the money the Fed is pumping into the banking system will do nothing about the structural, long-term change in the labor market brought on by the last recession. The Fed can, however, do something about prices by raising interest rates and ending the purchases of long-term bonds.

Not every central bank and monetary policy group has a dual mandate like that of the Fed. The charter establishing the European Central Bank set price stability as its sole objective.

Speaking in Berlin last week, ECB Gov. Jens Weidmann reminded everyone of this fact. He said governments must not rely on central bankers to solve their problems. Weidmann believes that when a central banker strays from the price stability goal in an effort to stimulate economic activity, it “weakens the principle of individual responsibility and engages in a kind of redistribution that should be decided by governments.”

As its 100th anniversary approaches, the Fed should get back to its roots. Like all organizations, it would do better pursuing one goal.

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prcrabb@nnu.edu

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