Why it might be the time to repeal the Fed’s dual mandate
Should 3% be the US central bank’s new inflation target?
Edward Yardeni
In the 2018 remake of A Star Is Born, Bradley Cooper sings a song titled “Maybe It’s Time To Let The Old Ways Die”.
The music comes to mind when thinking about the Federal Reserve after its latest policy meeting.
Maybe it’s time to get rid of the Fed’s dual mandate, which requires the central bank to achieve maximum employment and price stability.
That requirement was set by Congress in the Humphrey-Hawkins Act of 1978.
It amended the Federal Reserve Act and required the central bank to pursue these two primary goals, which have often conflicted in the past, and are doing so again now.
The Fed’s original mandate in the Federal Reserve Act of 1913 was to maintain financial stability.
The Fed first explicitly adopted a 2 per cent inflation target in January 2012.
This was formalised in a statement by the policy-setting Federal Open Market Committee, which announced a long-run goal of 2 per cent inflation, measured by the annual change in the Personal Consumption Expenditures (PCE) price index.
The decision was part of an effort to anchor inflation expectations and provide clarity on the Fed’s monetary policy objectives.
The FOMC doesn’t have an explicit target for the unemployment rate.
Still, the FOMC’s current consensus, as shown in the committee’s Summary of Economic Projections (SEP), is that the “long-run” unemployment rate is around 4.2 per cent.
The jobless rate was 4.3 per cent in August, and the PCE inflation rate was 2.6 per cent in July.
The FOMC tends to focus on core inflation, which excludes the volatile components of food and energy.
On this basis, inflation was at 2.9 per cent in July.
This combination suggests that the Fed has met its employment mandate and is nearing its inflation goal.
So, why did the FOMC vote to lower the benchmark federal funds rate by 0.25 percentage points this week?
That’s the first cut this year, and followed several months when Fed officials frequently said that they were in no hurry to lower interest rates.
In his post-meeting press conference on Wednesday afternoon, Fed chair Jay Powell acknowledged that inflation remains “somewhat elevated relative to our 2 per cent longer-run goal.”
However, he added that the FOMC is concerned about the recent significant slowing in payroll employment.
Could that be a sign of things to come with the Fed spending the next several years failing to bring inflation down to its 2 per cent target because it has decided that the labour market requires more of its attention?
When the Fed undershot its inflation target from 2012 through 2021, it embraced ultra-easy monetary policies.
Now that inflation is overshooting the target, the Fed may hesitate to tighten policy, fearing an increase in the unemployment rate.
If that is the case, inflation might remain around 3.0 per cent.
The labour market is currently challenging to read but consider the following:
• Immigration has declined sharply.
The foreign-born population and labour force have dropped by 1.9mn to 48.5mn and 1.5mn to 32.2mn, respectively, from March through August, according to the Bureau of Labor Statistics.
• Retiring baby boomers might explain why the labour force participation rate is falling.
Many of them have postponed retirement. But time is catching up with them.
The oldest of them will turn 80 next year.
They are hard to replace with new workers with less experience.
• Many companies may have hiring freezes because of uncertainty attributable to the Trump administration’s tariff policies.
Many of them may also be holding back on expanding their payrolls while they assess whether AI technologies might be a productivity-enhancing alternative.
Lowering interest rates really can’t resolve such structural issues.
Instead, rate cuts would probably boost demand for goods and services.
That could push up wage and price inflation, given that many of the labour market’s problems appear to stem more from a shortage of supply than from not enough demand.
Fed officials comfort themselves by claiming the federal funds rate level remains restrictive, given their long-term projection for it is 3.0 per cent.
But that’s becoming increasingly difficult to believe, given that real GDP growth is on track to exceed 3.0 per cent during the third quarter, after rising to 3.3 per cent during the prior quarter.
And if the Fed is on track to overshoot inflation for some time, then the FOMC might as well raise their explicit inflation target to 3.0 per cent.
Or, better yet, maybe it’s time to get rid of the dual mandate and have the Fed focus on financial stability, including keeping a lid on inflation.
The writer is president and chief investment strategist at Yardeni Research
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