The Federal Reserve was founded by Congress in 1913 “to provide the nation with a safer, more flexible, and more stable monetary and financial system.” Since then, it has largely met that objective. In recent years, the Fed has engaged more aggressive monetary actions designed to help improve economic growth and short-term employment.
But some of its actions may serve to increase the risk of low economic growth and high inflation rates over time. These actions include its decisions to buy trillions of dollars in federal debt and hold interest rates at historical lows despite rising inflation and mounting public debt/GDP levels. The Fed’s current policies serve to penalize savers and encourage taking on additional debt. These policies can result in excessive risk-taking and the creation of asset bubbles, which eventually burst.
The Fed’s purchase of trillions of dollars in federal debt since 2008 has provided some short-term economic gain while increasing the risk of great long-term economic pain. In addition, maintaining low interest rates in the face of higher inflation and increased federal debt burdens incentivizes those who want to embrace the dangerous “Modern Monetary Theory,” which asserts that U.S. deficit and debt levels do not matter absent excess inflation. Specifically, its proponents want to grow the government further despite tens of trillions in federal retirement liabilities and unfunded social insurance promises that have typically increased faster than the economy every year.
Of particular concern is the Fed’s recent announcement that it is adopting a reactive rather than proactive approach to inflation. Washington is already too myopic and reactive in nature. This reactive approach also provides further fuel to Modern Monetary Theory advocates while increasing long-term risks. Inflation is an involuntary and regressive tax on all Americans and, thus, must be controlled, especially in times of low savings rates.
Political pressure and congressional changes to the Fed’s mission may explain why it has taken these additional measures and adopted a reactive approach. In 1977, Congress amended the Federal Reserve Act, directing the board of governors of the Federal Reserve System and the Federal Open Market Committee 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." Given changes in the global economy, domestic labor force and the federal government’s unsustainable fiscal path, the time has come to update the Fed’s mandate.
Requiring the Fed to maximize employment is inappropriate. While the Fed can take steps to promote overall economic growth and individual opportunity, the changing nature of the economy and growing skills gaps involve factors that are beyond the Fed’s ability to effectively address. Specifically, immigration policy, education policy, unemployment compensation policy, infrastructure policy and tax policy are major factors in any attempts to maximize employment in today’s global and knowledge-based economy. These factors are best addressed by Congress and the president, along with elected officials at the state and local levels.
The Fed’s macroeconomic-oriented mandate should be updated to focus on promoting “long-term economic growth, stable prices and moderate long-term interest rates.”
In addition, Congress is increasingly focused on the short-term despite growing fiscal imbalances, and increasing societal income, wealth and education gaps that threaten our collective future. Therefore, the Fed must focus on our long-term and structural challenges by taking prudent actions to help address short-term economic challenges in ways that do not exacerbate our long-range challenges.
Just as the Supreme Court’s role evolved over time to be the protector of the Constitution, the Fed’s role must evolve. Specifically, the Fed needs to reassert its independence, be pro-active, focus more on the future and on areas where it has effective tools to employ. After all, the Fed should serve as one of the key checks and balances needed to keep our economy strong for both today and tomorrow. The time for Fed reform is now.
David Walker is a former United States comptroller general. He is the author of “America in 2040: Still a Superpower? A Pathway to Success.”