Pardon the title. But I didn’t know of a much more succinct way to say it without emphasizing the point. The thing is, I am tired of hearing about the Fed’s “dual mandate” of “price stability” and “full employment”. President Obama was discussing this in a NYT interview this week. But how often, during the history of the Fed, have we actually had “price stability” and “full employment”? Let’s take a look.
If “full employment” is anything under 5% unemployment and “price stability” is core inflation below the Fed’s 2% target rate then the Fed has achieved its dual mandate a whopping 3.5% of the time since 1957 when core inflation was first tracked. Yes, you read that right. THREE POINT FIVE PERCENT OF THE TIME.* That means the Fed has failed to simultaneously achieve both its mandates 96.5% of the time. I wouldn’t call that failure. I’d say they’re not even trying. And maybe they’re not?
Now, I’m fairly well versed in the structure of our monetary system. And I think it’s helpful to understand precisely what the Federal Reserve is in order to put the dual mandate into context. The Fed is really just a special bank with unique legal abilities given to it by Congress. But it’s a bank that exists primarily to help the other banks operate more smoothly. The Fed was created after the panic of 1906 precisely for this purpose – to oversee the private banking system and create some stability within the system. It does so primarily by acting as lender of last resort and regulator of the banking system.
Perhaps most importantly though, the Fed serves as an overseer of the payments system. The interbank system or reserve system is crucial to a smooth operating payments system where private competitive banking is involved. Before the Fed we basically had rogue banking. If JP Morgan didn’t trust Bank of America’s ability to meet its obligations then the system froze up and a whole lot of people would get fired just because companies couldn’t access the money system all because two banks were worried about one another’s solvency. The interbank market brought clearing into one place and helped reduce the risks in that system. The Fed is the entity that makes sure it all works smoothly.
Today, the Fed does more than just regulate the banking system and oversee the payments system. The Fed is actively involved in “monetary policy” and altering interest rates and influencing the banking system in various ways to try to achieve its dual mandate and hit economic targets. BUT ALL OF THIS WORKS THROUGH THE BANKING SYSTEM! So, before the Fed can ever even think of achieving some form of strategic monetary policy it MUST ensure the banking system is healthy. Said differently, the Fed is really an entity that exists first to ensure healthy banks and second, to ensure that that there is price stability and full employment. Of course, the Fed just about always succeeds in enriching the banks when problems occur. But it rarely, if ever, succeeds in actually meeting its dual mandate of price stability and full employment.
I honestly don’t understand why we obsess over the Fed hitting its “dual mandate”. It seems to me that the Fed is really just a bank servicing entity masquerading as something that can do much more than its history proves it’s capable of. To those of us who understand the monetary system it’s obvious that the Fed really has one mandate – make sure the banks are healthy. So maybe we should stop pretending the Fed is capable of achieving things it really can’t – like its dual mandate.
* The Fed’s “dual mandate” has evolved over time so it’s somewhat harsh to judge the Fed entirely by these figures.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.