Sunday, August 24, 2014

Federal Reserve "Dual Mandate" of Full Employment and Price Stability is Likely Unconstitutional and Radically New

 “Justice? - you get justice in the next world, in this world, you have the law.”
                                                                                                William Gaddis  JR

To most the following clearly outlines a "dual mandate", a long running permanent foundation stone of the powers mandated to the Federal Reserve by Congress, an ubiquitous feature of monetary policy:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.

 November 2010 FOMC Statement.

From then on it was posted in one way or another in every FOMC Statement:

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.

 July 30, 2014 FOMC Statement.

But the current use of "dual mandate" is not a legacy constitutional keystone empowering the Fed but is a radically new interpretation of the Federal Reserve Act perhaps now cynically used by Yellen and company.  The  current use of "dual mandate" is unconstitutional and is at odds with the academic literature on monetary economics and  a "ruse" so as to allow the Fed to make economic policy that they are excluded from doing so - thus its unconstitutionality.   

The “dual mandate” used in the Statement, the  official lawful communique by the Federal Reserve,  a radical ambitious (mis)interpretation of the law so as to justify the current focus of the Board of Governors, as led by the Chair, have on employment.  

This citing of “dual mandate” with "maximum  employment" as used is necessary to  justify the current Odyssean Fed and the principles of “forward guidance”.  It empowers the Fed to subjectively and secretively define what is  “maximum employment” – now a slippery qualitative and complex mixture of 19 distinct measurements of employment characteristics, the LMCI,  and a radical de-emphasis on the unemployment rate (UER-3), especially as the rate falls to levels that mocks the Fed.

The Fed's has justified their power rests on the “dual mandate”,  as defined by the Fed and by the  Board of Governors, specifically the Chair, deploying a English/Alvarez/Bernanke invention of the centrality of employment as the mainstay  of "communicative" policy.  But this use of the dual mandate is not a consensus of  Federal Reserve staff, nor with the staff at the Board of Governors.   
There is deep concern within the Fed  that the emphasis on employment, now qualified by the economic intuition of Yellon,  is an incorrect interpretation of the law and is either a theoretical non sequitur or a deliberate academic falsehood, a ruse.

Empowerment for current Fed forward guidance monetary policy rests upon the constitutionality of the “dual mandate”, provided it does not cause undue inflation, on a subjective constantly changing definition of  “full employment”.

This stress on employment is not reconciled with the Federal Reserve Act original intent nor by the amendment of 1977 and 1978.  The 1946 Employment Act does grant the President, or rather charges the President to table policy to Congress to provide “maximum employment”, and the 1978 Act does request the Fed to coordinate with that Executive defined policy.  But it is clear if the President does not table such policy and Congress does not insist upon the Executive to do so, the Fed is not to intercede or fill in the vacuum with monetary policy aimed at changing employment status.

If the “dual mandate” now offered at the end of a paragraph sites a mandate the Fed does not have granted by Congress, wording   starting with  “Consistent with its statutory mandate”, is a legal ploy by the Fed to end that paragraph with seemingly a repeat of the “statutory” with “dual mandate” but now, unlike the language of the statue it states “maximum employment”.

Thereby the Fed “switching” the statutory mandate of conducting monetary policy  "commensurate with potential production” with “maximum employment” is to switch a forward view of not impeding potential production being reached, and thereby the resulting in perhaps the sweet spot of “maximum employment”,  with the Fed current  "extraordinary" proactive current policy that has “maximum employment” as the only economic objective. This is not the law.

Since this cannot have gone unnoticed by the Board of Governors, I am certain that there has been discussion at the highest levels with the involvement of Alvarez etc, so  the use of "dual mandate" is a deliberate redefinition of the law by the Fed – and is therefore unconstitutional.  

The ability to show there can be a reasonable argument in that “dual mandate” is an incorrect read of the law, that the debate can even be had by thoughtful people both in the Fed and outside, should cause great concern.  

If in fact the argument prevails that the wording “dual mandate” is an incorrect read, perhaps to serve a political agenda by certain ascendant groups in Congress, will be devastating for the Fed and likely ends with Yellen’s dismissal. 

That will  take place if,  though well-meaning in terms of public service, the “dual mandate” does not work and then it will be easily shown it is a  legal ruse justifying a radical progression of the Fed to write macroeconomic policy for which they do not have the mandate or the constitutional power or power to do so.

What further compounds this problem and heightens risk is that the replacement of Federal Reserve Act "production" with many facets, with just  employment is an unproven and keenly debated thesis which involves the Phillips Curve, wage stickiness and many other confusing and unknowable economics.  

Employment has been massively disturbed by a once per century economic event, a solvency event, and it is not even known why unemployment rose as it did and why it is dropping in the fashion it is now. The various ways of describing unemployment are also not calibrating with  “demand side” of qualified labor showing an extremely strong if not on the edge of a bubble economy while unqualified workers and many of the supply side metrics of labor show perhaps a lack luster economy.

This is not the time for the Fed Board of Governors and FOMC  to rewrite law with unproven radical theories of how monetary tools connect to real world outcomes.

Yet the public and strangely almost all those in the financial industry are uncritically accepting of the Fed’s radical rewrite of law.  Most have the adamant view that “dual mandate” is written on bedrock and are derisive or dismissive when someone points this out. That they "know" the dual mandate was the intent of Congress and it has always been with us, at least since 1977.

The reality is that before the November 2010 Statement, the dual mandate of employment and inflation  was an abstract or descriptor of what the Fed did, a shorthand even, and was never considered  the statutory mandate.  “Dual mandate” was economic slang,  describing  what the Fed would monitor and consider but not the  statutory mandated objective. It was the “effect” and not the “cause”.  The original clause was a different “dual” – that of inflation and low long term interest rates. The title sentence of the Federal Reserve Act to this date does not even mention employment but states:

“An Act To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.

The Federal Reserve is not to write economic policy but first and foremost provide a Bagehot/Kindleberger central authority that provides lender of last resort services and maintains liquidity through the acquisition of assets from the private sector.  This is the most inspired public policy since Hamilton created the US Treasury and national fungible debt. And of course it is why the USA did not enter into depression in 2008.  But once that courageous and wonderful duty was implemented for the nation, the Fed – likely for a myriad of reasons – decided they must focus solely on “for other purposes” as they interpreted in the fly.

The first Congressional act that dealt specifically with employment, in 1946, did not even mention the Federal Reserve but  the President.  There was great concern that after the massive Keynesian stimulus of WWII remedied the crazy tightness of FDR working in coordination with the Federal Reserve tightening, the new President Truman with his reputation of being a “Blue Dog” and fiscally tight, was charged by Congress to deal first and foremost with employment.  It was thought that returning soldiers  returning to a peace time footing would throw the economy into depression, once again.  Therefore it is in error to cite the 1946 act as having anything to do with the Federal Reserve “dual mandate”.  This is the popular view error was  summed in a Washington Post letter to refute George Will taking similar lines to what I am stating  here.  Since the writer is Ken McLean who was a staffer in the writing of the 1977 and 1978 amendments to the Federal Reserve Act, it is thought to have authority and set the record straight.  McLean writes:

“The 1977 legislation referred to by Mr. Will was the Federal Reserve Reform Act, which among other things called upon the Fed to conduct monetary policy so as to "promote effectively the goals of maximum employment, stable prices and moderate long term interest rates." These goals are substantially equivalent to the long-standing goals contained in the 1946 Full Employment Act. The goals of the 1977 act were further affirmed in the Humphrey-Hawkins Act the following year.”  
(WP November 25 2010)

This is either at best in error, or worst disingenuous as nothing that transpired or said by Congress, even to date, supports his statement.  To cite the 1946 act is either an old man with a fogged mind or simply bunk.  The 1946 act has nothing to do with the Federal Reserve Act and the  the Federal Reserve amendment of 1977 citing of the 1946 act in 1978 clearly has employment as the effect that increased production would bring about, among other economic variables.  McLean also takes the wording of maximum employment out of context, not mentioning the preceding language.

The key and entire language is in Title 12 Chapter 3 Section 225 (a) which was changed with the 1977 amendment,  a change that was 64 years in the making, with the  addition of the term “maximum employment”:

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall 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.”

It is important to note where employment appears in regards to or dependent on what.  The statutory mandate is to “increase production”.  “Maximum employment” is the intended  results of “increase production” and explains why Congress is instructing the Fed to increase production. To have the Fed to assist or allow administrations policy for the country to reach potential production is the entire mandate, and it is assumed that maximum employment will be the end results, which by production growth  the Fed "promotes" for the long run.

The following year Humphrey-Hawkins Act elaborated further on this intent and “finding of Congress”  and clearly shows the non policy making role of the Fed  by adding a reporting section 225 (b), which by listing what Congress wants reporting on shows the placement of employment in this intent:

(b) Congressional Report. The Board shall, concurrent with each semi-annual hearing required by this section, submit a written report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Banking and Financial Services of the House of Representatives, containing a discussion of the conduct of monetary policy and economic developments and prospects for the future, taking into account past and prospective developments in employment, unemployment, production, ,investment, real income, productivity, exchange rates, international trade and payments, and prices.’

Clearly employment is only one of the several factors of “the long run potential to increase production”.  There are many variables, employment being only one of the variables.

Furthermore the 1978 Act has a preamble a “finding” of Congress which shows the limits and the expectations of how the Fed was to act in this system and with whom:

and by improved coordination among the President, the Congress, and the Board of Governors of the Federal Reserve System.

It is obvious that the mandate the Fed received from Congress was to implement policy that contained or prevented inflation in the context that would increase production.  The Fed was to then report on how the monetary policy impacted the variables that describe the whole spectrum of production.

There never was a dual mandate of “maximum employment" and inflation granted to the Fed by Congress.  It is clear “maximum employment” is the desired results but not the mandated objective.

The history of the Fed after the 1978 and a consideration of the “dual mandate” use since then, also shows that Congress has never granted the Fed the employment and inflation dual mandate.  Almost immediately after the 1978 Humphrey Hawkins Amendment, Volcker simply tossed onto the academic rubbish heap Miller’s use of the amendment – and Miller did not focus on employment but concentrated on economic growth via an easy Fed such that it would result in greater employment.  The results were the agony of stagflation, which in theory was never to occur, so the 1978 act suffered immediate discrediting and seemingly proof that the linkage of inflation and production was not understood.  So the entire academic basis for the 1978 was tossed out the window – and to many that is still its status. Volcker commented:

“… I don’t think that we have the choice in current circumstances — the old tradeoff analysis — of buying full employment with a little more inflation.
We found out that doesn’t work, and we are in an economic situation in which we can’t achieve either of those objectives immediately. We have to work toward both of them; we have to deal with inflation. And the Federal Reserve has particular responsibilities in that connection. “

From then until the mid 1990s, the Fed “dual mandate” was rarely mentioned as the Phillips Curve and the ability of the Fed to control the employment inflation tradeoff was a risible concept.  In fact employment was dropped from consideration and it was accepted in the sense Congress always had placed it, as a subset of production with production analysis framed in terms of realized and potential.  The rules appear where societal goals of full employment are not considered to be within the ability of the Fed to seek.  That is why all monetary policy “rules”  (ironically Yellen implicitly acknowledges this with her modified Taylor Rule, her “balanced rule” not having employment as an explaining factor) either have only inflation or inflation and some metric  qualifying production – usually an output gap value -   as the entire useful set of factors that the Fed can effect.  Since there is no academic literature, at least that I can find, that applies an employment variable into a “rule”, it shows that no one at the Fed thinks they can directly impact employment.  This is another indication that not only is “maximum employment” cited as the mandate an unconstitutional legal ruse, the use of employment in the dual mandate  is a communicative effort, or more correctly described as propaganda.  Bernanke admits as much, how the fed cannot impact employment but is in the domain of economic policy not monetary policy  in one of his last speech on November 19 2013:

“….the Federal Reserve could not adopt a numerical inflation target as its exclusive goal. Nor would it have been appropriate for the FOMC simply to provide a fixed objective for some measure of employment or unemployment, in parallel with an inflation objective. In contrast to inflation, which is determined by monetary policy in the longer run, the maximum level of employment that can be sustained over the longer run is determined primarily by nonmonetary factors, such as demographics, the mix of workforce skills, labor market institutions, and advances in technology. Moreover, as these factors evolve, the maximum employment level may change over time. Consequently, it is beyond the power of the central bank to set a longer-run target for employment that is immutable or independent of the underlying structure of the economy.”

This is amazing, to me as Bernanke is almost winking and rubbing his nose and admitting that the use of employment by the Fed is solely to fool the folks into having the expectations the Fed seeks – ergo “forward guidance”.

The problem now seems to be that some in the Board of Governors group, including Yellen have come  to believe that  the mandate is full employment, one of a duo,  and the Fed can bring about a qualified full employment status.  Or she is a most audacious liar and is cynically leaning into the Bernanke “communicative” purpose of the ruse – no harm no foul all for a good cause – to simply expand and maintain the newly found power of the Federal Reserve delivered to them by the crisis.

The use of employment in the dual mandate also didn’t appear until mid 1990s, and when hawks attacked   Greenspan who bravely made a call on productivity that allowed him to stay in relative ease throughout the 1990s, producing the “Great Moderation” and providing the strong capital market setting that allowed for the rise in productivity in the first place, the dual mandate was thrown in his face to justify the Greenspan policies. It seems the Princeton colleague to Bernanke, Alan Blinder was the first to use this approach, defending Greenspan from the hawks when he wasnt trying to oust Greenspan and replace him with Alan Blinder:  

“As usual, let me defend the status quo. We have a dual objective in the Federal Reserve Act now. I think it works very well. I think the case that it is broken and needs fixing is very thin. … There is no existing evidence — and I can’t say this too strongly — that having such targets leads to a superior trade-off. None at all. It is not one of those cases in which the evidence is equivocal. There is nothing that can be cited “  FOMC Minutes Jan 31 1995  Blinder

Then, perhaps with Blinder exiled from the Fed and the dotcom bust, employment in the dual mandate disappears from academic and Fed lexicon until the 2008 solvency event.

And even then the Fed was slow to discover that their main purpose in life was to honor the “dual mandate”, not even mentioning employment and mandate in the same sentence until the September 2010 FOMC.  I find this very strange as it certainly does not sync with those who think “of course” the Fed’s powers rest upon the long established core empowerment of the dual mandate – it is law!

“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the long run, with its mandate to promote maximum employment and price stability” September 2010 FOMC Statement"

But even as late as 2010 the Fed was yet to discover their constitutional bedrock of empowerment, the obvious long standing dual mandate of “maximum employment” and inflation.  But by September, as they started to get some heat over the startling swelling of the Fed’s  balance sheet via QE I and then the start of QE II, they had obviously switched the statutory mandate to support increased production with “maximum employment”.  By the November 2010 FOMC, finished form had been “discovered” and the shibboleth of dual mandate had been created with the Fed freely rewriting the Federal Reserve Act, despite the fact that they believed that the Fed could not directly affect employment, that employment was a nice results but since Miller no one at the Fed thought it had much to do, if anything, with monetary policy. Still the November 2010 Statement was the first statement of the dual mandate claim that has been in every statement since:

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.” November 2010 FOMC Statement

The belief in a “natural rate”, a Fisher rate, is the keystone to FOMC monetary theory.  The level of what the natural rate is is the subject of great debate, but almost all policy makers and analysts in the Fed system believe in the Friedman-Phelps natural rate thesis that the natural rate cannot have any impact on the level of employment.  
So based on the record, a read of the relevant law and the amendments, the academic use of “dual mandate” both inside and outside the Fed since the 1978 amendment, the widespread belief in Freidman-Phelps, and how the “dual mandate” slipped into the FOMC Statement and when it did so (late as November 2010) – the Fed, in truth,  do not believe they have a Congressional mandated objective to reach “maximum employment” and the use of the concept of “dual mandate” is for “communicative” purposes or to justify the  greatly expanded power base.   

In short, the formal use of “dual mandate” with maximum or full employment as one of the main objectives of the Fed, is clearly unconstitutional and a “ruse”.   Since Miller every FOMC was loath to express their objective or mandate in terms of unemployment or employment as it was felt that it could not be changed via monetary policy and was not the mandated task assigned to the Fed by Congressional law.

All that radically – and  in a very risky unconstitutional way – changed on November 3, 2010.

Those who think the dual mandate is a given, always a keystone to Fed policy and clearly the assigned duty of the Fed by Congress simply have not read the history of the Fed, considered the law in even a casual manner, and are naive.

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