The Fed Mandate		Printable Version (PDF)
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Contents Introduction Duties & Structure of the Fed The Fed's Authority Structure The Fed Mandate

The Federal Reserve defines its duties as falling into four general areas:

• conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
• supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payment systems. (Federal Reserve System, p 1)

Seal of the United States Federal Reserve System

But Fed policies are not always a simple matter of providing for the public good. For example, its role as a "lender of last resort" to the nation's financial system has been highlighted in its actions during the financial crisis. Each decision regarding whether or not to rescue a particular financial institution has implications for the health of the macroeconomy, but its decisions also disproportionately impact those banks it chooses to rescue (or not). In that respect, Fed decisions tend to serve some interests better than others, as critics have pointed out during the aftermath of the financial crisis.

The Fed's decisions on monetary policy — even if they are made with economic stability foremost in mind — also will benefit some groups at the expense of others. A common point of view argues that wealthier Americans will be more concerned with inflation than unemployment, and consequently will prefer a contractionary monetary policy, which would keep inflation at bay, so that the assets of the wealthy would not become devalued. (Hibbs; Saeki and Shull) Alternatively, an expansionist monetary policy to spur economic growth and stave off unemployment would, in this view, benefit Americans with fewer assets and those seeking employment.

Political scientist Andrew Taylor highlights how monetary policy can be redistributive and contentious: "Members of Congress generally wish for lower interest rates and an expansive money supply to stimulate the economy. The only exception to this rule of thumb comes when relatively high inflation motivates legislators, and especially Republicans, to call for a raising of interest rates." (Taylor, p 147) Richard W. Fisher, the current president of the Federal Reserve Bank of Dallas, believes that pressure to stimulate the economy is dangerous. Fisher recently wrote in an editorial, "Congress may seek to pressure the Fed to print its way out of this crisis. We know from history that when fiscal authorities attempt to monetize their debts, the result is inevitably inflation." (Fisher)

Implicit in this argument is a well-accepted short-term trade-off between unemployment and inflation. During normal economic times, if interest rates are lowered, that should translate into a greater demand for labor, higher wages, and — all else equal — higher inflation. Conversely, if interest rates are raised, there is less danger of long-term inflation, but unemployment is likely to rise. This trade-off necessitates that addressing concerns about employment, price stability, and long-term interest rates will require a juggling act.

The Fed mandate on how it navigates this juggling act was last revised in 1978. Since the 1940s, its mandate was to pursue "maximum employment, production, and purchasing power." (Santoni) Faced with both high rates of inflation and rising unemployment, Congress responded with the Humphrey-Hawkins Act, which stipulates, "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." The fact that the degree of specificity of its efforts is not dictated in any greater detail is important. The interpretation of this legislation is generally that the Fed has been given a "dual mandate," to seek both price stability and maximum employment (given that stable prices are generally associated with moderate long-term interest rates). (Fontana)

These multiple, perhaps contradictory goals give the Fed a greater freedom to pursue a range of policies. In practice, not all central banks enjoy such discretion. One counterexample would be the European Central Bank, whose guidelines require that bank to assign overriding importance to price stability. In the ECB's case, the goals are formulated to the degree that the decision-makers' goals are quantified and the bank must follow a strict formula. The Fed, in comparison, has no such constraint. (Gerdesmeier et al, p 1791)

With this dual mandate, how does the Fed operate? Former Board of Governors Chair Arthur F. Burns argued that during his tenure, "Every member of the Board, and every member of the Federal Open Market Committee, weighs the issues of monetary and credit policy solely from the viewpoint of the public interest and the general welfare. My colleagues at the Federal Reserve . . . live and work under a Spartan code that avoids political entanglement, conflicts of interest, or even the appearance of such conflicts." (Burns, p 23) This view is largely mirrored by Fisher's more recent comments: "We are not accountable to any Washington politicians, Democrat or Republican. We are politically agnostic and are guided solely by what we believe is the best way to encourage sustainable economic growth anchored by price stability." (Fisher)

Following the passage of the Humphrey-Hawkins Act, a new Fed Chair was appointed, Paul Volcker. Soon thereafter, the Fed shifted course, targeting and ultimately stabilizing the rising inflation rate. Alan Greenspan, Volcker's successor at the Fed, "described the so-called Volcker Revolution as a 'turning point' in the economic history of the U.S., which 'rescued our nation's economy from a dangerous path of ever-escalating inflation and instability.'" (Bailey et al, p 404-405)

Paul Volcker, Fed Chairman from 1979-1987, currently Chairman of the Economic Recovery Advisory Board

From the standpoint of Volcker's role as a technocrat, the story of his success illustrates the view that competent economists at the Fed can dramatically impact the fortunes of the American economy, and with creative use of the tools given to it, the Fed can be successful. From the standpoint of power and control, it is nonetheless implicit that the Fed's hands have not been tied. It is required to steer policies to favor long-term price stability and low unemployment, but Congress has left the weighing of these multiple responsibilities to the Fed. Fed policymaking does matter, and there are interests inside and outside government that might want to influence these policies. Part II of this Discovery Guide will explore whether and how much the Fed is guided by the will of the American people, the interests of Wall Street, the dictates of elected officials, or its own sensibilities.

List of Visuals

1. The US Federal Reserve building, July 30, 2009
   KAREN BLEIER/AFP/Getty Images, Taken from Proquest's eLibrary

2. US Rep. Ron Paul (L) D-TX questions Federal Reserve Chairman Ben Bernanke, April 2, 2008
   TIM SLOAN, Getty Images, Taken from Proquest's eLibrary

3. Federal Reserve Board Chairman Ben Bernanke, 2010
   TIM SLOAN/AFP/Getty Images, Taken from Proquest's eLibrary

4. The Great Depression led to expanded powers for the Federal Reserve
   New York Times, Mar 10, 1933, Taken from Proquest's Historical Newspapers

5. Federal Reserve Board, 1917
   http://en.wikipedia.org/wiki/History_of_the_Federal_Reserve_System
   Wikipedia, The Free Encyclopedia

6. Seal of the United States Federal Reserve System.
   http://en.wikipedia.org/wiki/File:US-FederalReserveSystem-Seal.svg
   Wikipedia, The Free Encyclopedia

7. Paul Volcker, Fed Chairman from 1979-1987, currently Chairman of the Economic Recovery Advisory Board
   Getty Images, 04-16-2010, Taken from Proquest's eLibrary


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