Two Words May Unfairly Haunt Fed Chairman Powell: Dual Mandate

Powell has indicated a willingness to re‐​evaluate how the Fed sets policy. Congress should follow his lead and reconsider the dual mandate.
March 21, 2018 • Commentary
This article appeared in The Hill (Online) on March 21, 2018.

Jerome Powell will hold his first press conference as Federal Reserve chairman at the conclusion of the Federal Open Market Committee (FOMC) meeting on Wednesday.

It will also be the first opportunity for the press to question Powell after a policy decision, which is likely to be a rates hike, which continues the Fed’s normalization plan. The interesting question surrounding this FOMC meeting is: Will Powell’s first press conference be the high water mark of his leadership?

The dual mandate might make the answer yes. 

The Fed is often described as an “independent” central bank. This means it is separate from the political process and makes its policy decisions without consulting Congress or the administration, and it is not subject to judicial review. Instead, the Fed sets monetary policy under a congressional mandate, known as the “dual mandate.”

Problems embedded in the dual mandate challenge anyFed chair, but it poses a particular problem for Powell. The dual mandate says the Fed ought to set policy by considering two unique objectives: stable prices and maximum employment. 

Conventional wisdom says the Fed should neither be overly concerned with inflation at the expense of potential employment nor be overly fixated on the labor market and miss building inflationary pressure.

An economic theory known as the Phillips curve suggests a tradeoff exists between inflation and unemployment, though the Fed has admitted such a relationship is not in the data.

The Fed is supposed to balance its two unique objectives, not focusing on one metric at the expense of the other.

Since January 2012, price stability has meant a symmetric 2‐​percent inflation rate target. While the Fed has missed this target to the downside almost without exception since adoption, there are signs in some data that inflation may be increasing. 

Much like they have been missing their inflation rate target, the Fed has chronically misjudged the unemployment rate. Over the years, they have routinely predicted that the economy has reached full employment. Yet, the unemployment rate has continually declined.

Despite the Fed’s poor forecasting, Powell is inheriting good numbers. Inflation data are inching upward, with long‐​term expectations at 2 percent, and according to the latest Bureau of Labor Statistics data, unemployment remains at 4.1 percent, as low as it has been in nearly 20 years.

According to the dual mandate, this is an historic success.

But here’s the rub: With history as any guide, and given the length of the ongoing recovery, it is quite unlikely that the inflation rate and the unemployment rate will hold at 2 percent and 4 percent, respectively, throughout Powell’s term as chair. Furthermore, the odds that both numbers will continually improve over the next four years are effectively zero.

But these two indicators do not give a full picture of the economy, and the dual mandate may not offer a reliable signal if the Powell Fed is failing. Indeed, the dual mandate may be a cause for criticism even when goodthings happen in the economy.

Consider the unemployment rate. Currently it is low, but that tells an incomplete story. The unemployment rate is the percentage of people in the labor force who are not employed. But to be in the labor force, one must be either employed or making “specific efforts” to find a job. 

Disillusioned people no longer looking for work are not part of the labor force and thus do not factor into the unemployment rate. There is good reason to believe a large number of U.S. “workers” fit this category.

If the economy begins growing faster — as the Fed now believes that many factors once seen as headwinds for the economy are turning into tailwinds — some, maybe many, of those people may start looking for a job. As they look for work, they will be re‐​entering the labor force and thus factoring into the unemployment rate. 

Before they are employed, these job seekers would put upward pressure on the unemployment rate. But would an unemployment rate increase of this type, driven by a growing economy with more and more people searching for meaningful work, signal a policy failure by the Fed?

Of course not. But according to the dual mandate it would signal failure. The Powell Fed could be judged a failure, simply by letting the economy improve. 

But it’s not the only problem with the dual mandate. It’s always been an open question whether the dual mandate is appropriate for judging the performance of any Fed chair. Having two target variables often leads to muddled policy: Which target should take primacy in policymaking and for how long?

And worse, too often Fed officials believe that they can trade these variables off each other, potentially allowing inflation in exchange for higher employment. Thankfully some Fed officials are questioning this faith‐​based orthodoxy.

The dual mandate has always had problems embedded within. With the potential to make future Fed policy look like a failure due to economic improvements, the dual mandate’s problems have never been clearer. Powell has indicated a willingness to re‐​evaluate how the Fed sets policy. Congress should follow his lead and reconsider the dual mandate. 

About the Author
Tate Lacey
Former Policy Analyst, Center for Monetary and Financial Alternatives