The Fed Is Not As Powerful As We Think
But we’ve fostered an unhealthy dependency on its leader.
This past week marked the annual gathering of bankers, financial officials, and other economic experts hosted by the Kansas City Federal Reserve Bank in Jackson Hole, Wyoming. On Friday, Fed Chair Janet Yellen and European Central Bank head Mario Draghi both spoke; in a slow week for the markets, these speeches received the bulk of the econ media’s attention, and Yellen’s remarks were heralded for days as the week’s major financial event.
This emphasis on the utterances of the Fed chair is only one aspect of a deification of the Fed and whoever heads it. The elevation of the Fed chair to current heights is not benign. It fosters an unhealthy dependency and excuses policymakers and market participants from making their own judgments, as well as their own mistakes.
More problematic, however, was the topic of Yellen’s speech: the labor market. Don’t get me wrong. The labor market is a crucial economic topic. But the notion that the Fed should be responsible for the labor market is both new and flawed. The so-called “dual mandate” of the Fed is to focus on price stability and on employment. But the idea that the Fed can do much to affect employment is, at the very least, questionable.
The pronouncements of the chair of the Federal Reserve now occupy a special place in the financial ecosystem. The Fed chair regularly appears before Congress to give an assessment of the economy, and these appearances receive considerably more attention in media and financial circles than equivalent briefings by the Treasury secretary, let alone the chairpersons of the National Economic Council or the Council of Economic Advisers.
The Fed has not always occupied this role. Once upon a time, the chair of the Federal Reserve was simply one of a number of major players in the economic policy firmament, but not seen as the axis around which all revolved. The Treasury secretary, for instance, was typically thought of the primary economic policymaker, along with Congress itself.
Nor did the Fed’s decisions act as decisive market events. Before 1979, according to the St. Louis Fed, the open market committee of the Fed didn’t even target interest rates. And until the tenure of Paul Volcker, who was widely credited with aggressive interest rate policy that ended the stagflation of the 1970s, there was no public announcement of the Fed’s decisions. Interest rate policy had to “inferred” from the subsequent movement of rates in global markets.
That began to shift under Volcker, and changed dramatically with the 1987–2006 tenure of Alan Greenspan. Coinciding with stock market booms, Greenspan’s time as chairman led to a new focus on the Fed. The rise of new cable networks such as CNBC and the explosion of online financial news added to the mix, and soon enough Greenspan was heralded as the primus inter pares of financial policymakers. He was widely regarded as a financial wizard who guarded the nation’s prosperity, and when Ben Bernanke took over from Greenspan, he perpetuated that role when he was thrust into the financial crisis of 2008–2009. Yellen, newly appointed, now bears the expectations of markets and policymakers that she is the primary guardian of the economic system.
The prominence of the Fed today owes something to its pivotal role in times of crisis. Providing liquidity during the panicky weeks of late 2008 was crucial to stabilizing the system and preventing a complete implosion. But the Fed also assumes such an outsize place because of a decision by Congress nearly 40 years ago to expand the bank’s mandate. During a particularly difficult time economically, when inflation was soaring and jobs were evaporating, Congress launched a Hail Mary pass of policy desperation in 1977 and added to Fed charter the “dual mandate” of providing for “maximum employment” along with “stable prices.” The idea was that there is a clear relationship between prices, money supply, and employment, and that therefore the Fed could do much to improve employment by using monetary policy.
That relationship, however, has always been more assumed than proved. The belief is that when there is more and cheaper available credit, businesses will then use that capital to expand and hire, and consumers will use that capital to purchase homes and thus set in motion a potentially virtuous cycle of more demand for goods and services.
In the past six years, the Fed has gone to herculean lengths to provide trillions of dollars of liquidity. But while there has been a flood of capital, businesses that rely on capital markets to fund future growth have been loath to spend or hire. There has been significant improvement in labor markets since the depths of 2009, but you would be hard pressed to connect that to monetary policy per se. It is also clear that Fed policy cannot directly shape wages and income, at least judging from current trends—wages and income are improving, but not in relationship to the sheer volume of money pumped into the system by the Fed. Perhaps the trends would have been substantially worse without aggressive monetary policy. But that can’t be proved.
Yellen, from her past writings through her speech this week in Jackson Hole, takes the dual mandate very seriously. She cares deeply about the fate of labor and wages, and has already tasked the considerable staff of economists at the Fed to think more deeply and with greater nuance about employment trends. She has broadened the range of metrics well beyond the headline employment rate in order to analyze the shifting sands of labor in the U.S. today.
That is admirable. We could all use more rigorous analysis about both the markets in general and about work and wages today. But that does not mean that the Fed is suited to address the challenge. The Fed actually has few tools at its disposal, powerful though those tools are. Monetary policy is a blunt instrument, not a targeted one. The same can be said of interest rates. It can flood the system with money (or dam it up when growth is booming), but it cannot control where that money is channeled.
The dual mandate, combined with the way that markets and policymakers in Washington have turned the Fed into the dominant voice about the economy and labor market, places far too much weight on the central bank. The dual mandate makes little sense given what the Fed is able to do. Labor markets should be the primary focus of Congress and the executive, as well as state and local governments that can address the specific challenges with targeted policies. The fact that the government has been utterly incapable of that is not a justification for placing that responsibility on an institution that largely lacks the tools to do much about the problems.
For 30 years, the profile of the Fed and its responsibilities has been expanding. It is time for that to end. Hold Congress and the White House responsible for dealing or not dealing with the labor market. Look to other voices along with the Fed in trying to figure out financial markets as well as the economy. The Fed is a powerful, important institution, but it is not and cannot be an economic deus ex machina—and nor should its chair be looked to as the primary guide to a complicated world.
This article first appeared on Slate.