Pragmatic Capitalism

Capital for Living a More Practical Life

About the Fed’s Triple Mandate

Some people seem surprised by Janet Yellen’s comments that give the appearance that she adheres to a triple mandate:

“I pledge to do my utmost to keep that trust and meet the great responsibilities that Congress has entrusted to the Federal Reserve–to promote maximum employment, stable prices, and a strong and stable financial system.”

I don’t really see how this is surprising.  The Fed claims to have a dual mandate – to maintain price stability and promote maximum employment.  But it can really only achieve these mandates if it FIRST maintains a stable financial system.  Make no mistake here.  Janet Yellen is an exceedingly intelligent woman.  She understands the Fed and the Fed’s history like the back of her hand.  And I can assure you that she is uniquely familiar with the Fed’s history.  She knows full well that the Fed wasn’t created to hit employment and inflation targets, but was actually created to support the payments system.  As the Fed has explained:

“By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system.”

The Fed system was created to support the private payments system controlled by the banking system at the time.  In fact, the Fed system is modelled after the New York Clearing House model which was a privately managed clearing house for bank payment settlement that existed prior to the Fed.  After the crisis of 1907 the government got more involved in the process to help oversee and manage the process.  The result of this was the Federal Reserve System which is really just one big payments system attached to the banking system.  Which is another reason why it’s so bizarre that some economists want to “keep banks out of macro” while also focusing on nothing but central banking.  To understand central banking and monetary policy IS TO UNDERSTAND BANKING.

The Fed was created with one primary mandate – to help stabilize the payments system.  And if it doesn’t achieve this goal then it can’t even begin to think about inflation and employment.  Some economists seem to have missed this important fact about the history of the Fed and have instead constructed this mythical world where the Fed hits employment and inflation targets without working with the banking system.  Thankfully, Janet Yellen isn’t in that camp.

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