All eyes on the Fed as it pursues 'dual mandate'

TRADITIONALLY, the primary goal of a central bank - the regulatory authority of monetary policy - was seen as providing a country's currency with price stability by controlling inflation, in addition to being the sole provider and printer of notes and coins in circulation.

Based on that description, the role of the US Federal Reserve aka Fed would be quite simple: To take action when inflation rears its ugly head.

But in reality, since the late 1940s and the end of the Great Depression, the Fed has been pursuing multiple goals after the US Congress legislated in 1946 that the role of the federal government was to "promote maximum employment, production and purchasing power".

About two decades later, Congress went even further when it instructed the US Federal Reserve in 1975 in the "Full Employment and Balanced Growth Act" (aka "Humphrey-Hawkins Act") to "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". In short, maintaining price stability and fighting inflation was not enough.

Since then, the Federal Reserve has been operating under what became known as its "dual mandate" of "stable prices" and "maximum employment". Which means that unlike, say, the European Central Bank (ECB), fighting inflation is not the only task of the Fed. The US central bank needs to ensure that the prices you pay for goods and services remain relatively stable and that everyone who wants a job in the American economy can find one.

Demonstrating that the Fed was taking its dual mandate seriously, former chairman Ben Bernanke announced on Dec 12, 2012, that under his leadership the central bank will keep interest rates close to zero until the unemployment rate falls to 6.5 per cent. That was the first time that the US central bank tied its interest rate policy to a numerical employment target.

Hence it would be impossible to understand the aggressive monetary policies that have been pursued by current Fed chair Jerome Powell since the onset of the global pandemic in 2020 without recognising the role that the Fed has been assigned to play in maintaining the health of the economy while ensuring that the unemployment rate remains low.

Monetary policy goals

Or as chairman Powell himself has reiterated several times in the last three years: "At the Federal Reserve, we are strongly committed to achieving the monetary policy goals that Congress has given us: maximum employment and price stability." Notice that in his statements during the pandemic his references to "maximum employment" preceded the mentioning of "price stability".

Hence the Fed under Powell's leadership not only greenlighted gigantic fiscal stimulus programmes adopted by the administrations of both presidents Donald Trump and Joe Biden, notwithstanding the risk that they could trigger inflation.

Powell's Fed has also bought more than US$4 trillion in assets during the pandemic, including Treasuries, mortgage-backed securities and even corporate bonds, the equivalent of 18 per cent of GDP. That has been a much more massive intervention compared to the scale of the stimulus that followed the global financial crisis, and it has expanded the total balance sheet of the Fed to US$8.3 trillion.

Powell has clearly taken huge risks here especially when he seemed to continue pursuing this loose-money policy when the inflation rate has started rising.

While even many inflation hawks applauded his actions during the pandemic that may have helped rescue the American economy and prevented a new Great Depression, his insistence on describing a soaring inflation rate at the end of last year as "transient" or "transitory" and continuing to hold interest rates near zero have been criticised even by some inflation doves.

At that time, Powell, not unlike US Treasury Secretary Janet Yellen, his predecessor at the Fed, believed that the inflationary pressures reflected the condition of an American economy exiting the pandemic-induced economic recession.

The expectation was that as Covid-19 was eradicated, businesses would open, the unemployment rate would fall, the oil markets would stabilise, the pressure on the supply chains would be reduced, and used car prices would not be too high - and the inflation would return to a rate the central bank could live with.

Chairman Powell as well as Secretary Yellen told US lawmakers last week that they were ready to retire the term "transitory" and agreed that inflation may prove to be more than a short-term issue.

But neither of them forecasted that the American economy was threatened by dangerous inflationary spikes or that that their fiscal and monetary policies were at fault.

'Transitory'

As Powell told Congress, the word "transitory" was supposed to signal that the blip in prices "won't leave a permanent mark in the form of higher inflation", and noted that most forecasters, including the Fed, "continue to expect that inflation will move down significantly over the next year as supply and demand imbalances abate"; although he added that "the factors pushing inflation upwards will linger into next year".

In a way, while the report issued by the US Labor Department last week, suggesting that the 210,000 employees that American employers added last month were below expectations, the unemployment rate did fall to 4.2 per cent from 4.6 per cent in that month.

That number indicates that despite soft job creation, one of the Fed's goals - full employment - is being achieved, especially if one considers that the unemployment rate was 6.7 per cent in December last year.

That means that the Fed is now ready to start taking the necessary steps in response to an inflation rate that is around 6 per cent, without causing too much disruption to the economy or spooking investors.

Indeed, the expectation now is that the Fed is poised to step up tapering its stimulus programmes or "quantitative easing" at its meeting this month.

After approving in its meeting last month, plans to shrink its monthly asset-purchase programme by US$15 billion each in November and December, the Fed could now reduce the purchases by US$30 billion next month, and stop them altogether by the middle of next year.

In that case, the Fed would have more flexibility to raise interest rates in 2022 if the inflation rate remains at above target. Hence after assisting in fulfilling the first part of its dual mandate, full employment, the Fed would start to put more weight on the second task, price stability.