The Fed Doesn't Have A New Mandate

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Marcus Nunes directed me to a recent Project Syndicate piece by Alexander Friedman:

In this world, there are only two tragedies," Oscar Wilde once wrote. "One is not getting what one wants, and the other is getting it." As the US Federal Reserve inches closer to achieving its targets for the domestic economy, it faces growing pressure to normalize monetary policy. But the domestic economy is no longer the Fed's sole consideration in policymaking. On the contrary, America's monetary authority has all but explicitly recognized a new mandate: promoting global financial stability.

The US Congress created the Fed in 1913 as an independent agency removed from partisan politics, tasked with ensuring domestic price stability and maximizing domestic employment. Its role has expanded over time, and the Fed, along with many of its developed-country counterparts, has engaged in increasingly unconventional monetary policy - quantitative easing, credit easing, forward guidance, and so on - since the 2008 global financial crisis.

Now, the unconventional has become conventional. A generation of global market participants knows only a world of low (or even negative) interest rates and artificially inflated asset prices.

But the Fed's dual mandate remains in force. And while the Fed's recent rhetoric has been dovish, the fundamentals of the US economy - particularly those that supposedly matter most for the Fed - indicate a clear case for further rate hikes.

Consider, first, the Fed's employment mandate. The unemployment rate is down to just 5%, job growth is strong and consistent, and jobless claims have been on a clear downward trajectory for several years.

As for the price-stability mandate, the oil-price collapse has naturally affected headline figures over the past year, but the trend in core inflation (excluding the energy component) suggests that the Fed is falling behind the curve. Core CPI is at a post-crisis high, having risen 2.3% year on year in February, and 2.2% in March.

As I get older I get steadily grouchier, and that last sentence really set me off. Sometimes I wonder if people who write that sort of thing are intentionally trying to mislead the public, who may not know that the Fed doesn't target the CPI, indeed it doesn't even care about the CPI. But I'll try to take a deep breath and assume that Mr. Friedman is just someone who is ignorant of the Fed's actual policy goals, and was not trying to intentionally deceive. He does work for the Bill and Melinda Gates Foundation, so he's probably a good guy.

For the record, the Fed targets the PCE index, which has been running below 2% and is expected to continue running below 2%.

What about the main issue, has the Fed adopted a third mandate? I suppose anything is possible, but older people like Janet Yellen and I are pretty set in our ways. She's a traditional Keynesian, who cares a lot about unemployment and low inflation, and I can't imagine why she would add a third goal.

Here's what's really going on. The global Wicksellian real rate has fallen very sharply, and is likely to stay low. People like Krugman/DeLong/Summers/Kocherlakota understand this, as do market monetarists, but many people don't. To them it seems strange that rates are so low, despite 5% unemployment.

One of the groups that do understand the new reality is the financial markets. When they see a sign of the Fed pushing rates up prematurely, they fire a shot across the bow of the Fed, in the form of a sharp asset price break.

To the uninitiated, that might make the financial markets look sinister, as if they are trying to push the Fed to keep rates low in order to benefit the top 1%. But in fact traders don't coordinate their decisions (indeed that would be almost impossible). Stocks falls on signs of excessive tightness because traders genuinely feel that at the current time, even a 2% or 3% fed funds rate would cause a deep recession (which would also hurt the bottom 99%, by the way).