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The Federal Reserve's dual Mandate

Cullen,

I am fairly new to your twitter account and website, however, I am a big fan of your writing and ideas. I honestly can't think of another person that "gets it", at least in the areas I am interested in and read your articles

I've have been poking around on your site regarding subjects I am interested in and came across and outstanding and eye opening article you wrote in July 2013, "The Fed's Dual Mandate is Bull Sh*t".

https://www.pragcap.com/feds-dual-mandate-bull-sht/

In this article, you lay out a strong case in regards to how poorly the Fed performs in regards to meeting both of the mandates at the same time over its history, but you also point out some things they are really good at. The Austrians want to "End the Fed", but, I think there is a reason

I've been toying around with a thought experiment in my head about what would be the likely positive and negative impacts (maybe some unintended consequences) if the Fed announced tomorrow they have changed their dual mandate to "Stable Prices and Maximum Wage growth, instead of maximum employment". I'm not sure of your stance perspective on the productivity vs. wage growth chart in the U.S. chart that dates back to the 1850's I believe, but, it seemed for 120+ years as productivity increased, so did wages and stagnant wage growth since the late 1970's, which hasn't kept up with productivity, is hurting the American economy and middle class.  I'd love to hear your off the cuff thoughts or if this is even a tangible goal or what this would look like in terms of monetary or fiscal policy. I think the problem isn't full employment at whatever the cost, say the economy producing higher and higher levels of minimum wage jobs, but an economy that is producing higher and higher paying jobs, without significant or unmanageable inflation.  Thank you in advance for your time.

(note/quick background, in case you are curious: I am a commercial banking portfolio manager for a regional bank and my areas of interest primarily include macroeconomic topics like the Fed, debunking the loanable funds and money multiplier still being taught, fractional vs. full reserve banking, sovereign money, debating UBI that does not include an increase to the money supply and something akin to commodity or tangibly backed currency and/or money, but not necessarily Gold or other precious metals). I'm not at all interested in the world of personal finance, investing, Wall Street, etc.) I think what I like the best about your work is you remain open minded and take the best of innovative or alternative ideas like MMT or Austrian economics, respectively, with out fully jumping in.)

Hi @jhaze,

Thanks for the nice comments. I try to stay "pragmatic" and objective I guess. I think one important lesson I've learned is to never box yourself into a view by aligning yourself with a strict ideology because ALL OF THEM have something valuable to add.

My view on the Fed is simpler - I basically think it's just a big clearinghouse for overnight payments. If you look at the Fed and its history you can clearly see that all the Fed did was replace the NY Clearinghouse (a private entity) for the clearing of payments. You had a bunch of banking panics in the 1800's and early 1900s that made it clear that a private clearinghouse didn't work during bank panics because the private entities would all stop operating with one another. The Fed is just a public entity version of this that refuses to shut down when people get scared. So, payments keep clearing. It's pretty smart actually and 2008 proved that it works really well.

Now, the crazy thing about this is to think about the NY Clearinghouse and imagine people thinking that this Clearinghouse was responsible for full employment and price stability because it settled payments and helped set an overnight interest rate. Wouldn't that be nuts? But somehow we all got duped into thinking that a public version of this clearinghouse can somehow achieve that goal. It makes no sense.

So, I guess my short answer is that the Fed isn't a very good entity to be solving these things in the first place. That doesn't mean they have no role to play here, but they don't have the goals to achieve full employment, price stability, financial stability or wage stability.

I think you need other govt agencies and Congress to be more involved if you want some balance of those things, but even they can't fix them all....

Not sure if that helps or not, but I hope so.

Have a great weekend.

 

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Yes, the money supply is determined by private demand for loans.  Money distribution is determined by commercial bank preference.  The effects of the Fed's pushing on a string is probably marginal and seems to impact the psychology of the stock market more than anything else.

Quote from Cullen Roche on 08/09/2019, 1:31 PM

Hi @jhaze,

Thanks for the nice comments. I try to stay "pragmatic" and objective I guess. I think one important lesson I've learned is to never box yourself into a view by aligning yourself with a strict ideology because ALL OF THEM have something valuable to add.

My view on the Fed is simpler - I basically think it's just a big clearinghouse for overnight payments. If you look at the Fed and its history you can clearly see that all the Fed did was replace the NY Clearinghouse (a private entity) for the clearing of payments. You had a bunch of banking panics in the 1800's and early 1900s that made it clear that a private clearinghouse didn't work during bank panics because the private entities would all stop operating with one another. The Fed is just a public entity version of this that refuses to shut down when people get scared. So, payments keep clearing. It's pretty smart actually and 2008 proved that it works really well.

Now, the crazy thing about this is to think about the NY Clearinghouse and imagine people thinking that this Clearinghouse was responsible for full employment and price stability because it settled payments and helped set an overnight interest rate. Wouldn't that be nuts? But somehow we all got duped into thinking that a public version of this clearinghouse can somehow achieve that goal. It makes no sense.

So, I guess my short answer is that the Fed isn't a very good entity to be solving these things in the first place. That doesn't mean they have no role to play here, but they don't have the goals to achieve full employment, price stability, financial stability or wage stability.

I think you need other govt agencies and Congress to be more involved if you want some balance of those things, but even they can't fix them all....

Not sure if that helps or not, but I hope so.

Have a great weekend.

Thanks for the reply, Cullen. I'm pretty ticked off right now because I worked on a detailed response to your post and when I hit submit it timed out and I lost all of it. Cutting and pasting from Word from now on. I will do my best to recreate the magic i just lost in the morning. Have a good evening. ~ Jack

@jhaze,

Ah, bummer. Sorry. Not sure why that would have happened....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche
Quote from Paul Lebow on 08/12/2019, 9:27 AM

Yes, the money supply is determined by private demand for loans.  Money distribution is determined by commercial bank preference.  The effects of the Fed's pushing on a string is probably marginal and seems to impact the psychology of the stock market more than anything else.

Yes! Yes! Yes! But, I'm surprised how many people don't realize or understand that.

I think I have this right, but the Fed wants banks to lend during the last/great recession, banks decide, "nope... too much risk, not in the mood", we'll turnaround and use the money you are giving us to lend and interest it in treasuries instead and profit from the difference.

As someone who works in commercial banking, I can't believe how poorly so many of these topics are still being taught in colleges and written about in textbooks, but to be honest, the majority of my colleagues don't think about these things and are just as clueless.

I saw this open letter from a student facility that I thought was refreshing, even though I haven't read it in detail yet (just skimmed it).

https://pine-maastricht.nl/pine-open-letter/

I agree with the premise of your last sentence in that it not only makes intuitive sense, but it also makes sense from my commercial banking experience. Very rarely do we decide to decline a loan because say it has a 1.19x debt service coverage ratio and then make the loan a week later if the variable rate index or our fixed loan pricing guide interest rates decrease, increasing the DSCR to 1.20x or 1.25x. Yet, I do stand that there are a number of deals that would work at a 4% interest rate that wouldn't work at 8%, from a bank approval standpoint.

At the same time, I think it is criminal for banks to be able to create IOUs that function as money in our system out of thin air, as a result of dual entry accounting, where you can just offset a loan with a deposit account and benefit from the seigniorage.

I would like to ask, both of you, your thoughts regarding the effectiveness of Paul Volcker and company continuing to raise rates in the 1980's until we got inflation under control. As in Paul's point, if its impact is just marginal, why was it effective or better yet what alternative explanation would you give, since raising rates comes at a tremendous cost to some including the working poor.

Thank you both for your time and sharing your thoughts and insights,

~ Jack

 

Its truly amazing that those in the banking industry can be the most dense when it comes to understanding the true nature of banking.  There are some stunning epiphanies on the part of some central bankers when they step back and realize the absurdity of a sovereign nation relying on money created by a private industry.  The burgeoning monetary reform movement is partly based upon your observations.  You might want to take a look at the large compilation of resources on banking and money creation in the "resources" section of http://www.monetaryalliance.org.

I can put out a kitchen fire with a fire hose like Volker did - lots of collateral damage.  Makes one wonder why demolishing the housing market and pumping money into tax cuts for the wealthy was seen as the only way to curb inflation due to external causes such as the winding down of the Vietnam war and the gas crisis.

The Fed was not JUST a replacement for a clearinghouse.  Those larval MMT's were all about in force at the time and put their mark on it to get it approved through Congress.  Don't underestimate the power of populism.  It's happening again atm and if we're not super careful we'll wind up with even more socialism than the original intention.

Most other misunderstandings about the Fed arise from not understanding that we were on a gold standard at the time.  Certain things that seem zany today made complete sense under a fixed exchange rate system.

And for gawd's sake the Fed has always had a TRIPLE mandate, not a dual!  Anytime someone says the Fed has a dual mandate then you know you are dealing with an ignoramus.  Look it up (Wikkipedia does not qualify, it's the blind leading the blind.)

 

And if you got back further in time, there were more roles than a triple mandate.  This double and triple mandate seems to be a political summarization that happened over time.