Of Mandates, logistical problems, and public menaces

About currency, the US Constitution says, among other things, in Article 1, section 8, The Powers of Congress:

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures

In simplistic terms the monetary system and any extraneous currencies circulating within US borders are a sole power of Congress. In 1914, Congress delegated execution of that power to the Federal Reserve, originally with a mandate of providing an elastic currency, in the Federal Reserve Act.

The Federal Reserve Act has been amended several times in the last century, notably, creating the Federal Open Market Committee to formally consider monetary matters in the 1930s, and in 1979 to add a list of shall-do’s concerning monetary policy; the sentence comprising the mandates begins with the word “shall,” The Federal Reserve “shall manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production; so as to promote maximum employment, stable prices, and moderate long term interest rates.” Whatever else the FOMC might or might not do, it must do the “shall” – manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production.

Maximum employment is not the mandate. Stable prices is not the mandate. Moderate long term interest rates is not the mandate. Managing monetary and credit aggregates commensurate with the economy’s long run ability to produce is the mandate (the command immediately following the word “shall”). Nevertheless, in January 2012 the FOMC endeavored to define the policy framework that would best meet its mandate as a regime of flexible inflation targeting at 2% on the headline PCE index. Basically put, an explicit inflation targeting regime would produce only one aspect of the mandates, stable prices, as it meets difficulties with supply shocks. And so to mitigate the effects a rigid monetary regime on the economy during supply shocks, flexibility was put into inflation targeting so that the FOMC is much more than mindlessly focused on inflation.

At least, that is the idea of the flexibility in flexible inflation targeting. In practice however, not even the flexible inflation targeting regime is well enough defined as to provide stable expectations of the FOMC’s reaction function – thus stable anything concerning economic outcomes. It currently isn’t even well enough defined as to provide discipline in behavior among FOMC members as evidenced by years of near 50% below target inflation and continual revision of the natural unemployment rate.

The FOMC has been given a legislative command – manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production so as to promote maximum employment, stable prices, and moderate long term interest rates. In its most literal sense, it means to have ample cash and credit available so that economic expansion occurs as the supply side is able to expand. There are some common queues as to when the economy is at full capacity – unemployment drops to a very low level and core inflation starts to rise. At that point, is when following the mandates would call for the FOMC to ‘gently’ apply the brakes – slow the pace of economic growth as to moderate changes in prices.

The FOMC has recently noted some problems with the status quo, however, among them being the enormous buildup in reserves as a result of crisis policy execution, possible market distortions, and how to unwind all of this. To me, these are logistical problems encountered as a result of poor policy and poor execution of policy, and have very little to do with the general welfare. What matters is economic performance. What matters is the economy’s long run ability to increase production, the promotion of maximum employment, stable prices, and moderate long term interest rates.

However, it appears that the FOMC recently has put its logistical problems ahead of the mandates: ahead of potential output, ahead of labor and ahead of stable prices – ahead of the general welfare – given that economic conditions do not appear to warrant a tightening cycle, though it is promised to begin this year, some times characterized by FOMC officials as coming as planned despite economic weakness and declining inflation expectations. Even after being allowed to liberally interpret its mandates and define a monetary policy regime that would best meet its interpretation of them, it refuses to execute on that interpretation or explain how it can solve its logistical problems while achieving consistency with it in the quickest possible fashion. As such, the FOMC currently amounts to little more than the sum of its logical problems created as a result of experimenting outside the bounds of the mandates. Thus, as an institution it has ceased to function toward any achievable societal benefit, having transformed into a longer term public menace.

The current evolution of the FRAT Act under consideration would do little more than more of the same. It allows the FOMC to interpret its mandates and establish a rules-based regime that would best meet them, which it presently has done, but declines to place a priority on execution. A new law that formalizes interpretation of the mandates and definition of how to meet them, something already done in practice, will produce little material change in outcome.

If it is the intent of Congress to provide meaningful reform, a review of the structure of institution as a whole is required to engineer protections to prevent it from falling victim to regulatory capture and becoming unanchored from its legal foundation. Within the institution, nothing else should matter than its legal foundation and objectives, and there should be plenty of legal and financial trouble involved on a personal level for officials involved with veering outside the legislated limits. As currently stands in the Federal Reserve Act, Congress has no ability to impose discipline regarding anything the FOMC does, not even to fire its Chairman; and any required accountability to Congress is purely symbolic.

The carrot and stick approach is much better: pay scale commensurate with performance toward the mandates, with fines and imprisonment for violating more prohibitive restrictions on financial associations, ethics rules that apply to everyone within the Federal Reserve System. And yes, I am suggesting the implementation of a mini police state within the institution. I want more IG investigations of ethics violations. I want more punishment of violations – up to and including prison terms. I want more reward for reserve system personnel for doing right by the only thing that matters – the mandates.


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