Fed would do better job if it kept interest rates normal and stopped buying bonds

They’ve done their part, but perhaps they’re trying to do too much.

The Federal Reserve this year has not only pushed down interest rates, but has also directed cash to those industries hobbled by the shutdowns and the pandemic. The Fed continues to expand the markets to which it directly lends well beyond its traditional role in banking.

Earlier this month, the Federal Open Market Committee reiterated its plans to continue purchasing U.S. government bonds and mortgage-backed securities with the objective of keeping long-term interest rates low. The committee also stated the Fed was “committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.”

It’s this effort to try and do both — grow employment and keep prices stable — that’s making the job of these policy makers so difficult.

The Federal Reserve Act was signed by President Woodrow Wilson in 1913. 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 solely to maintain the stability of this new single U.S. currency.

In 1977, Congress amended the Federal Reserve Act to add the goal of “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 issues, like a pandemic, keep people out of work.

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.

All the money the Fed is pumping into the financial markets will do nothing about the coronavirus, nor anything about structural changes occurring in our labor market, such as automation and online services.

The Fed can, however, do something about prices by returning interest rates to normal levels soon. They can also reduce financial market volatility by ending the purchases of long-term bonds.

The Fed needs to think about getting back to its roots. They’ve done their part, but they would do better sticking to just one goal.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. prcrabb@nnu.edu

This story was originally published November 18, 2020 at 11:54 AM.