The Fed's dual mandate and the 1977 law that gave it two masters

Define the word "mandate." It means a task assigned to an agent by someone with the authority to assign it. A mandate that contains two tasks that sometimes conflict, with no instruction about which wins, is not a mandate. It is a permission slip. The Federal Reserve has held such a slip since 1977, and I would like to explain how it came to hold it, what it has meant, and why conservatives should want it replaced with a single clear instruction.

The terms

The Federal Reserve is the central bank of the United States, created by the Federal Reserve Act of 1913. It sets short-term interest rates and controls the size of its balance sheet, and through those tools it influences the quantity of money and credit. Price stability means that the general price level does not change much from year to year. Maximum employment means that the economy is using its labor force as fully as it sustainably can. A mandate is the objective that Congress sets for the Fed in statute. An inflation target is a specific rate of price increase that the central bank aims to achieve.

The claim I am going to defend: the Fed's dual mandate creates an institutional bias toward tolerating inflation, because the costs of unemployment are visible and immediate while the costs of inflation are diffuse and delayed. A single mandate for price stability would serve both goals better, because stable prices are the foundation for long-run employment.

How the law got there

Before 1977

The original Federal Reserve Act of 1913 contained no explicit statement of the Fed's macroeconomic goals. It created a system to provide an elastic currency and supervise banks. For decades the Fed operated under a set of understandings, including a commitment to the gold standard, which limited its discretion. In 1951 the Fed and the Treasury reached an accord that freed the Fed from the obligation to keep Treasury borrowing costs low, a step toward independence. The Employment Act of 1946 declared that the federal government should promote "maximum employment, production, and purchasing power," but it was directed at the government generally, not at the Fed in particular.

November 1977: the Federal Reserve Reform Act

By the mid-1970s the country was in the midst of stagflation, a story I tell in The Great Inflation of the 1970s was a policy choice, not bad luck. Congress responded by writing the Fed's goals into the statute. The Federal Reserve Reform Act of 1977, signed in November of that year, amended the Federal Reserve Act to direct the Board and the Federal Open Market Committee to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.

Notice that list. Three goals, not two. In practice, economists pointed out that long-term interest rates will be moderate if inflation is low and stable, so the third goal is largely a consequence of the second. That is why the statute is called a dual mandate, though its text names three objectives. The nickname stuck, and so did the ambiguity about the weight to give each.

October 1978: Humphrey-Hawkins

The following year Congress passed the Full Employment and Balanced Growth Act of 1978, universally called Humphrey-Hawkins for Senator Hubert Humphrey and Representative Augustus Hawkins. It was signed by President Carter on October 27, 1978, and it added numerical goals for the economy, including an inflation goal of 3 percent or less and a goal of zero inflation by 1988, each qualified by the employment goal. The Fed reports to Congress twice a year, with testimony from the Chair, under the Federal Reserve Act's reporting requirement, and that testimony is the main public occasion on which a Fed chair answers to Congress.

The numerical goals were aspirational and were never met on schedule. The reporting requirement lasted.

The problem with two masters

Now the argument. I will number the premises.

One. The two goals do not conflict in the long run. A stable price level supports sustainable growth and employment, because it lets households and businesses plan. Almost every economist agrees with that.

Two. The two goals can conflict in the short run. When the Fed tightens policy to fight inflation, it slows demand and may raise unemployment. When it eases to reduce unemployment, it may raise inflation. The Fed must decide, in each meeting, which risk to weigh more.

Three. The costs of the two failures arrive differently. Unemployment is felt at once, by identifiable people, who can be interviewed and who vote. Inflation arrives gradually and is spread over everyone, and its cause is hard to identify. A central bank that listens to the loudest voice will lean toward fighting unemployment.

Four. That bias accumulates. If each error leans the same way, the result is a drift upward in inflation. That is what happened in the 1970s, as the Fed eased repeatedly under pressure from the White House and from Congress, and the inflation each cycle left behind became the new baseline.

Therefore a mandate that tells the Fed to weigh both without a priority invites it to resolve the tradeoff in the politically comfortable direction.

The steelman

Let me state the defenders' case in words they would accept.

The people who wrote the dual mandate were not careless. They believed that a central bank that ignores unemployment is a central bank that can cause real harm. The Great Depression, they would say, was in large part a monetary failure in which the Fed allowed the money supply to collapse. A single price-stability mandate might allow the Fed to impose a recession for a small gain in inflation, at enormous human cost.

They would also say that the dual mandate has not led to disaster. The Fed under Paul Volcker raised rates sharply in the early 1980s and broke the inflation, with the dual mandate in force. The 1990s and the years after saw low inflation and low unemployment. And in practice, they say, the Fed's own commitment to a 2 percent inflation target has made the mandate effectively lexical: it pursues price stability and treats employment as the second goal within that constraint.

That is a serious defense, and each of its points has truth in it.

The answer

First, on the Depression: nobody proposing a single price-stability mandate is proposing that the Fed ignore deflation. A mandate for price stability is violated by deflation just as it is by inflation. The Fed of 1930 to 1933, which let the money supply shrink by about a third, would have failed a price-stability mandate catastrophically, because prices fell hard. A stable price level is a guard against both errors. That is one reason I do not accept the idea that a single mandate means a hawkish central bank in all circumstances.

Second, on Volcker: the dual mandate was in force, and the Fed broke the inflation, but it did so against enormous political resistance, and it took the stagflation of the 1970s and a deep recession to make the political environment tolerable. The success shows that the Fed can resist the pressure. It does not show that the pressure was absent, and it does not tell us what would have happened if a different chairman had been in the chair. A system that works only when it has a Volcker is not a system.

Third, on the claim that 2 percent has made the mandate effectively lexical: that is an acknowledgment of my point. The institution found it necessary to adopt a numerical price-stability target because the statute left too much to discretion.

Where the 2 percent came from

Here is a piece of history that many people find surprising. There was no law that set the Fed's 2 percent inflation target. It was adopted by the Federal Open Market Committee itself, formally, in a statement on longer-run goals issued on January 25, 2012. Before that, the Fed had operated with an informal understanding, and its officials had referred to a comfort zone around 2 percent for some time.

The number itself has its roots in New Zealand. In 1989 New Zealand passed the Reserve Bank of New Zealand Act, which made price stability the central bank's primary objective and required it to agree on a numerical target with the government. The first target ranges set in 1990 were low single-digit figures, and the experiment, a clear single goal with public accountability, was widely seen as a success. Other central banks, such as the Bank of Canada in 1991 and the Bank of England in 1992, adopted inflation targets of their own, and 2 percent became a common benchmark. The European Central Bank was created under a treaty that made price stability its primary objective.

So the American Fed adopted, by its own decision, an idea that was invented abroad as a way to give a central bank one clear job. That is a remarkable fact. The countries that invented inflation targeting put price stability first. The United States kept the dual mandate and layered a target on top of it.

Rules versus discretion

The deeper debate is about whether a central bank should follow a rule or use judgment. Conservatives are divided, and I take the division seriously. In 1993 the economist John Taylor proposed a simple rule that has been influential since. It says that the policy interest rate should respond to two things: how far inflation is from its target and how far output is from its potential.

In its simplest form, the Taylor rule sets the nominal rate equal to 2 percent, plus current inflation, plus half the gap between inflation and the 2 percent target, plus half the output gap. A worked example, labelled hypothetical: suppose inflation is 4 percent and the economy is at potential, with an output gap of zero. The rate would be 2 plus 4 plus half of (4 minus 2) plus zero. That is 2 + 4 + 1 + 0 = 7 percent. If inflation is 2 percent and the output gap is zero, the rate is 2 + 2 + 0 + 0 = 4 percent. The rule says that when inflation is above target, the central bank should raise the rate by more than one-for-one, so that the real interest rate rises. That is the lesson of the 1970s in a formula.

Defenders of discretion respond that rules cannot anticipate every circumstance: a financial crisis, a pandemic, a war. Those are fair points. Even Taylor treats the rule as a guideline for comparison, not a straitjacket. But the discipline of comparing actual policy to a rule is valuable, because it makes a departure visible. If the Fed holds rates far below what the rule recommends, citizens and Congress can ask why. I compare this approach with the gold standard and with Milton Friedman's money-growth rule in Gold standard, Friedman's rule or today's Fed, three answers compared.

What a single mandate would change

I propose a statute that says the Fed's primary objective is price stability, defined as a numerical inflation target that is reported publicly, with a requirement that the Fed explain in writing any extended deviation. Employment would not vanish from the Fed's attention, because a central bank pursuing price stability must watch the economy's spare capacity. It would simply be a means and not a co-equal end.

Several reasons support it. It aligns the institution with what it can actually control, since monetary policy influences inflation reliably over time but cannot permanently raise employment. It protects the Fed from political pressure by giving it a clear answer: the law says that is not my job. And it makes accountability possible, because a single target can be checked against results, and two goals can be traded off in any proportion without anyone being able to say that the Fed failed.

The recent experience shows the stakes. The inflation of 2021 to 2023, analyzed in what caused the inflation of 2021 to 2023, weighing the honest evidence, began while the Fed, with a framework that stressed the employment side, kept its rate near zero. A mandate with a single priority would have made that choice harder to defend. And the damage to families on fixed incomes, whom I discuss in inflation hurts the poor most, and the arithmetic of a fixed paycheck, is the human cost of an institution that waits.

The constitutional point

I should anchor this in the Founders, as one always should. Article I, Section 8 gives Congress, not the Fed, the power "To coin Money, regulate the Value thereof." The Fed's power is delegated by Congress and Congress can change it by statute. That means the mandate is Congress's responsibility, and the dual mandate is a decision Congress made, in 1977, and can unmake. The Fed does not need to be blamed for following the instructions it was given. The proper target of criticism is the legislature that wrote an ambiguous instruction and then complained about the results. If Congress wants stable money, it should say so in plain language and require the institution it created to report against it.

The case in brief

1. The Federal Reserve Reform Act of 1977 directed the Fed to promote maximum employment, stable prices and moderate long-term interest rates, and the Humphrey-Hawkins Act of 1978 added numerical goals.
2. The two goals converge in the long run but conflict in the short run, and the costs of unemployment are visible while the costs of inflation are diffuse, which biases a central bank toward tolerating inflation.
3. The Fed's 2 percent target was adopted by the Fed itself on January 25, 2012, borrowing an idea from New Zealand's 1989 law, which put price stability first.
4. A rule such as Taylor's, which would call for a 7 percent policy rate at 4 percent inflation with no output gap, makes departures visible even when judgment must override it.
5. Congress should replace the dual mandate with a single price-stability objective, publicly reported, because deflation also violates it and because the instruction belongs to Congress, not the Fed.

What you can do: read the semiannual monetary policy testimony of the Fed chair, then write to the members of your congressional delegation who sit on the banking committees and ask whether they would support a single price-stability mandate.