Academic journal article Business Economics

The Federal Reserve's Mandate: Long Run

Academic journal article Business Economics

The Federal Reserve's Mandate: Long Run

Article excerpt

Given the slow recovery of the U.S. economy, quantitative easing of monetary policy in the form of U.S. Federal Reserve asset purchases has been attractive. However, it is not clear that the current and likely future economic environment warrants this policy, given its long-term risks. This paper outlines these risks and makes the case for a return to conventional policy by allowing currently held assets to roll off the Federal Reserve's balance sheet as they reach maturity and by resuming more conventional monetary policy. This is not a quick fix, but it is less risky than current policy in achieving the Federal Reserve's long-run dual mandate of price stability and maximum employment.

Business Economics (2011) 46, 13-16.

doi:10.1057/be.2010.36

Keywords: monetary policy, quantitative easing, interest rates, inflation expectations

I appreciate this opportunity to engage and interact with business economists from around the country regarding the policy choices now confronting the nation, especially those confronting the Federal Reserve. In setting out my views, I'll first spend a minute describing the economy's performance and then turn to the matter of quantitative easing vs. my preferred path of gradual steps to a renormalization of monetary policy.

1. Short-Term Outlook

Currently, a major and necessary rebalancing is taking place within our economy. This includes the deleveraging of consumers, businesses, and financial institutions, and it's during a time that state and local governments are struggling with budgets and mounting debt loads. In this context, a modest recovery with positive overall data trends should be seen as highly encouraging.

Following a bounce back from restocking earlier this year, the economy has slowed but it has not faltered. GDP growth has averaged about a 2 1/2 percent annual pace since the first of the year. Industrial production is showing growth of almost 6 percent, and high-tech more than double that. The consumer continues to buy goods, with personal income growing at more than a 3 percent rate, personal consumption expenditures at about 3 percent, and retail sales at more than 4 percent. And the U.S. economy has added more than 850,000 net new private sector jobs since the first of the year. While modest, these are positive trends for the U.S. economy.

The issue is, of course, that while private jobs are being added within the economy, it is not enough to bring unemployment down to where we all would like to see it. Unemployment remains stubbornly high at 9.6 percent. With such numbers, there is, understandably, a desire and considerable pressure for the Federal Reserve to "do something, anything" to get the economy back to full employment. And for many, including many economists, this means having the Federal Reserve maintain its zero interest rate policy or further still, engage in a second round of quantitative easing--now called QE2. Some are even suggesting these actions are necessary for the Federal Reserve to comply with its statutory mandate.

2. Interpreting the Policy Mandate

The FOMC's policy mandate is defined in the Federal Reserve Act, which requires that: "The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

There is, within the Act, a clear recognition that our policy goals are long-run in nature. In this way, the Act recognizes that monetary policy works with long and variable lags. Thus, the FOMC should focus on fostering maximum employment and stable prices in the timeframe that monetary policy can legitimately affect--the future. The FOMC must be mindful of this fact and be cautious in pursuing elusive short-term goals that have unintended and sometimes disruptive effects. …

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