Some Thoughts on the Dual Mandate: Right Goals, Wrong Agency?

By Stephanie Kelton

The statutory objectives for monetary policy known as the “dual mandate” were imposed by Congress as part of the the Federal Reserve by Act of 1913.  The mandate charges the Federal Reserve with responsibility for achieving two broad macroeconomic goals: “maximum employment and stable prices.” Much has been made (especially by those on the left) of the benefits of having a dual mandate.  In contrast to the European Central Bank, which operates with a single mandate — price stability — the dual mandate is supposed to ensure a more balanced outcome in the public’s interest.

As Matt Yglesias put it:

The idea of a “dual mandate” to pursue both price stability and maximum employment is that even if a pure look at inflation would lead the Fed to want tighter money, it ought to check out the employment situation and think twice before tightening if joblessness is widespread.

But not everyone is so enamored with the idea of requiring the Fed to care as much about fighting unemployment as it does about restraining inflation. For example, not a single Republican expressed support for the dual mandate when the issue came up during a presidential debate on September 12, 2011.

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.

Former Fed Chairman Paul Volker recently made a similar (but far more nuanced) argument with respect to the dual mandate.

I know that it is fashionable to talk about a “dual mandate”—the claim that the Fed’s policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory. It is operationally confusing in breeding incessant debate in the Fed and the markets about which way policy should lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic. It is illusory in the sense that it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience.

The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity. Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.

Volker argues that the Fed would actually do a better job of maintaining high employment if  it was freed of its dual mandate and simply assigned  broad responsibility for maintaining price stability over time.  Perhaps this position is not surprising, given that there was not a single mention of “maximum employment” in any of the Fed’s written directives while Volker was Chairman of the Federal Reserve (see here). But his real beef stems from concerns about the “extraordinary” measures — Quantitative Easing (QE) in particular —  the Fed has adopted in an effort to carry out the employment side of its mandate.

Volker is basically worried that the Fed is under too much pressure to bring down unemployment and that recent policy has introduced substantial risks in terms of inflation, financial instability and future credibility.  On the unprecedented buying of Treasuries and mortgage backed securities, Volker says:

[T]he extraordinary commitment of Federal Reserve resources, alongside other instruments of government intervention, is now dominating the largest sector of our capital markets, that for residential mortgages. Indeed, it is not an exaggeration to note that the Federal Reserve, with assets of $3.5 trillion and growing, is, in effect, acting as the world’s largest financial intermediator.

He’s also worried about the use of  “forward guidance” (i.e. the Fed’s promise to keep interest rates low for as long as unemployment remains above 6.5%, even if inflation creeps above its historical 2 percent target).

The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives—up today, maybe a little more tomorrow, and then pulled back on command. But all experience amply demonstrates that inflation, when deliberately started, is hard to control and reverse. Credibility is lost.

It’s important to note that Volker isn’t suggesting that the dual mandate should be lifted so that the Fed can pursue a different set of policy goals.  Quite the contrary!  What he’s saying is that it would be easier for the Fed to deliver what everyone wants — higher employment and price stability — if we weren’t monitoring them so closely.  Apparently, monetary policy is sort of like using a urinal — it’s just harder to do it with someone watching.

Anyway, my point is this.  Nearly everyone seems to believe one or both of the following: (1) high levels of employment and low rates of inflation are worthwhile goals; and (2) the Fed is the right agency to deliver on these goals. I don’t dispute the former, but I often wonder about the latter.  Heck, even the current Fed Chairman sometimes sounds unconvinced.  Here’s an exasperated Ben Bernanke confessing that, despite the extraordinary steps the Fed has taken to expedite the recovery, monetary policy is “not even the ideal tool.”

Whereas Bernanke has only hinted at the need for a fiscal partner, former Fed Chairman Marriner Eccles, openly advocated the use of fiscal policy as the most effective way to fight both unemployment and excessive inflation.   In the depths of the Great Depression, Eccles pushed for a payroll tax cut, calling it “the most important single step that can be taken” to stimulate consumer buying power. Years later, just prior to the near tripling of U.S. war expenditures, Eccles urged lawmakers to raise the payroll tax in order to stave off an inflationary episode. Indeed, as his Special Assistant made clear in the following letter, Eccles considered adjustments in fiscal policy (in this case an increase in the payroll) to be “the most effective anti-inflationary means of reducing purchasing power.”

Discussions like these continued after the war.  Indeed, as Paul Samuelson notes in his classic text Economics (10th Ed), a serious debate took place after the national Commission on Money and Credit advocated greater reliance on fiscal policy to achieve the macro goals of full employment and price stability.  The problem, as Samuelson explained, was that the Commission recommended that the President be given unilateral authority to adjust tax rates in response to changing macro conditions. He explained the opposition thusly:

Philosophically, some reformers dislike the need to have human beings decide policy. They speak of a ‘government of laws and not of men.’ They advocate setting up automatic rules and mechanisms that would go into action without ever depending on human decisions. . . we have not yet arrived at a stage where any nation is likely to create for itself a set of constitutional procedures that displace need for discretionary policy formation and responsible human intelligence.

This is basically what the Taylor Rule was supposed to do — i.e. remove political pressures/human agency from monetary policy by automating decisions about whether and by how much to adjust the federal funds rate.  With waning evidence that the Fed has sufficient firepower to carry out its dual mandate, perhaps it’s time to develop a fiscal analogue to the Taylor Rule.

Follow Stephanie on Twitter @deficitowl 

16 responses to “Some Thoughts on the Dual Mandate: Right Goals, Wrong Agency?

  1. The Taylor Rule should be, “For each one-percent increase in unemployment, the central bank should raise the nominal interest rate by no less than one percentage point.”

    Warren Mosler: “Since the government is a net payer of interest, lower [interest] rates reduce spending, thereby increasing fiscal drag.”

  2. Cory Hoffman (@LakeErieLiberal)

    Sounds like an excellent Ph.D for a grad student at UKMC.

    Perhaps, in some other possible world, you grant the FED authority over the payroll tax rate or a VAT rate like it now has control over the FED Funds rate. Maybe you let the federal funds rate go to zero like Warren Mosler talks about and instead of the fed raising interest rates along a Taylor Rule, they follow a “Kelton Rule” and the FRTC (Federal Reserve Taxation Committee) or whatever you would call it raises payroll tax rate or VAT rate for X percentage increase in inflation?

    If payroll tax rate goes to zero/near zero and we’re still not at a satisfactory level of full employment (on a Bill Mitchell NAIBER standard of course), we could do actual “helicopter drops” via crediting citizen bank accounts or something or other.

    • VAT is as much of a legalistic morass as the income tax. The biggest problem with our tax system today is that it employs far too many accountants and lawyers.

      The payroll tax would be effective at influencing aggregate demand, but not perfect. What it really changes is incomes, but only incomes of wage earners. What needs to be adjusted is not incomes, but spending.

      Business gross receipts is a nearly perfect proxy for total spending in the economy, and thus aggregate demand. If the tax is applied there, it directly controls what is needed to be controlled. The others are indirect, and thus less effective.

      • Cory Hoffman (@LakeErieLiberal)

        Very good points! So a Kelton Rule for a tax on Business Gross Receipts.

  3. I first became acquainted with Modern Monetary Theory at your very interesting symposium at UMKC on public-service employment, commemorating Martin Luther King’s birthday a couple of years ago, and have subsequently read King’s last book, Where Do We Go from Here: Chaos or Community. There, he describes full employment as the necessary next step in advancing the civil rights movement in this country, with the public sector as the employer of last resort when commerce fails to utilize our nation’s human resources.
    This strikes me as a public-policy question independent of fiscal policy per se: such a commitment would be a vast improvement in our national cultural policy — the core values we share and work toward in trying to perfect our democracy. Since the elimination of CETA’s public-service provisions with the first Reagan administration, we’ve had nothing like this. I had hoped — in fact, in light of the 2008 economic collapse, expected — that the Obama administration would bring something like this, or the WPA, forward in our national discussion; but I have seen no serious effort along these lines. Even into Obama’s second term, the administration’s discussions of jobs have so completely focused on business that the nonprofit and governmental sectors seem to have been ignored.
    Your symposium inspired hope that public-service employment might reenter our political discourse, aided by MMT’s insight that deficit spending is a diversionary issue when public investment is needed. Have I missed some serious discussion of this idea since the time of your seminar?

  4. “The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity. ”
    Exactly. The Fed is a “one-armed swordsman”. As per Lerner’s functional finance paradigm, we need all instruments at our disposal, not just (i/M). Without (G, T), we’re just engaging in “NASCAR Economics” (left turns only)! We need Fiscal Policy.

  5. Yes, yes, YES.

    The fiscal adjustment should be a broad-based, low-rate tax that can be quickly changed in small increments.

    The most effective tax collectors in our economy are corporations, so I have proposed in these blogs that the corporate income tax be replaced by a business gross receipts tax. All businesses, not just corporations, and all revenues without deductions or exclusions. This tax would be the workhorse of the tax system, and could allow for reform of income and payroll taxes.

    As for regulation by law instead of by humans, the law and the rules to be applied would also be written by humans, and without human oversight the inevitable shortcomings of the human-written rules could do great damage. Making it an autonomous machine does not eliminate the vagaries of human error, it just cements those vagaries into a less flexible format. The Federal Reserve Board has proven to be a good methodology for changing interest rates, and so a similar committee could work to manage changes in the gross receipts tax rate. Rules should restrict them to small increments at quarterly time intervals, but the specific changes ought to be discretionary within the guidelines. We certainly cannot wait for Congress to act on each change, and investing the power in a single politician is far too dangerous and prone to corruption.

    With a fiscal adjustment regime, the Fed could be released from its dual mandate, and relegated to operating the reserve system and bank regulation. They might even, some day, be directed to maintain a fixed 0% Fed funds rate.

  6. “The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity. ”

    It really can’t even do that very well. It can try control the supply of reserves through quantitative easing, but it’s only impact on the broader money supply is through rate setting. Setting rates only impacts the demand for private credit and then only at the margins (as in, I would borrow this money at 3%, but not at 5%). The fed could totally restrict private credit creation if it wanted (set the rate at an absurdly high amount), but it is limited by the zero lower bound (where we are currently at) and can’t continue to encourage additional credit creation after that point.

    One also has to then ask if private credit creation is really the optimal way to control inflation and employment. Most of us on this site would likely agree that it is not. Better to control the actual flow of currency which is done through fiscal (tax and spend) policy not monetary policy. In summary, when the economy is operating at a normal pace, the Fed can make slight tweaks in demand through private credit creating by tweaking interest rates. Outside of that narrow band of normal, it has zero power to do anything.

  7. Having TWO institutions, first the central bank and second an body of elected politicians having a say on stimulus (the first doing monetary stimulus and the second doing fiscal stimulus) is raving bonkers. One might as well have a car with two steering wheels each operated by a different person.

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  10. What do you call an economy that is left in state of perpetual “output gap”? Because mainstreamers (Paul Krugman) are talking about eventual recovery as if it was pre-ordained destiny. Price movements are supposed to cure unemployment problems in the long run even without help from fiscal policy.

    We should challenge this notion that economies will recover all on their own. Tight fiscal policies could very well leave private sectors too poor to consume enough to close output gaps that have emerged. Voodoo thinking does not help here.

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  12. There is no solid evidence that monetary policy does what it is advertised to do. As Warren Mosler recommends, the policy rate should be set to zero and fiscal policy guided by the sectoral balance approach and functional finance, with the MMT JG to mop up residual unemployment and provide a price anchor at the JG wage as the optimal path to achieving and maintain full employment and price stability at optimal economic growth.

    What monetary policy does, especially the dual mandate, is to provide politicians with a fig leaf for failing to act, or adopting fiscal policy that is destabilizing.

    Moreover, a politically independent central bank setting monetary policy establishes a technocratic command system at the apex of the economy, which is anti-capitalistic and anti-democratic. Other than global warming and weapons of mass destruction, perhaps the greatest threat to the world is the politically independent power that is accumulating in central banks and international institutions like the BIS, IMF and World Bank.

    It’s time to recall the words of Georgetown Professor Carroll Quigley:

    “The powers of financial capitalism had (a) far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations. Each central bank… sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world.”
    Carroll Quigley, Professor of History at Georgetown University and member of the Council on Foreign Relations, in Tragedy and Hope: A History of the World in Our Time (PDF), Volumes 1-8, New York: The Macmillan Company, 1966