It appears that over the past 18 months the Federal Reserve has given itself a third, unofficial mandate.
In 1977, Congress gave the quasi-independent central bank what's known as a dual mandate: It is supposed to promote "the goals of maximum employment, stable prices and moderate long-term interest rates.” In its monetary policy announcements, the Fed interprets the first two clauses as its goals, saying that it “seeks to foster maximum employment and price stability.”
But since tying its zero-interest rate policies to the level of unemployment in December 2012, the Fed has added another condition to its conduct of monetary policy. In determining how long to maintain its efforts to ease monetary conditions, the Fed says, it will consider not only “measures of labor market conditions, indicators of inflation pressures and inflation expectations," but also "readings on financial developments.”
What’s new in that formulation is the jargony phrase “readings on financial developments.” What that means, briefly, is that the Fed will consider the possibility that it is inflating bubbles in conducting monetary policy, in addition to the dual mandate considerations of employment and inflation.
The need to avoid bubbles is increasingly a concern as the Fed stretches into its sixth year of maintaining near-zero interest rates and undertaking quantitative easing -- both programs intended to boost the prices of assets such as stocks and real estate.
Chairwoman Janet Yellen has said that she would not rule out using monetary policy to prick a financial bubble. In her confirmation hearings in November, Yellen told Sen. Robert Menendez, D-N.J., “I would like to see monetary policy first and foremost directed toward achieving those goals Congress has given us,” but “an environment of low interest rates can induce risky behavior. And I would not rule out monetary policy conceivably having to play a role” trying to deflate a bubble without a financial panic.
Last week, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, the most “dovish” member of the Fed’s monetary policy committee, spelled out in more detail why he thought the Fed must now prioritize avoiding financial crises.
In a speech in Boston Thursday, Kocherlakota said, in effect, that the underlying weakness of the U.S. economy may mean that the Fed is not able to achieve full employment and stable prices without inflating bubbles.
Kocherlakota said that the Fed may have to maintain even negative inflation-adjusted inflation rates up to five years or more for a variety of reasons, including that credit remains tight and that workers and businesses are hesitant to borrow and spend because they fear adverse shocks and are uncertain about government policy.
As a result, Kocherlakota concluded, the Fed “may only be able to achieve its macroeconomic objectives in association with signs of instability in financial markets.”
Kocherlakota's comments echoed those of former Obama economic adviser and Clinton Treasury secretary Larry Summers in describing what he referred to as the problem of “secular stagnation.”
Secular stagnation, as Harvard professor Summers described it late last year to the International Monetary Fund, is a situation in which, for whatever reason, the economy cannot generate sufficient consumer demand for goods and services to avoid a recession without extraordinary support from the central bank. One implication of the secular stagnation thesis is that the economy can be trapped at near-zero interest rates for as long as the particular circumstances that are depressing demand are in effect.
That means, in Summers’ analysis, that the Fed could face the possibility of a permanent recession if it doesn’t reduce easy money, or the possibility of constantly inflating bubbles if it keeps low interest rates.
Summers may not be right, but the recent focus on financial stability among members of the Fed’s monetary policy committee suggests that they’re worried he is.
This week will provide some new data on the strength of consumer demand. The Census Bureau will report on retail sales for May on Thursday. Then, on Friday, the University of Michigan will release its gauge of consumer sentiment conducted with Reuters. The National Federation of Independent Business will also release its survey of small business sentiment on Tuesday.
On Tuesday, the Labor Department will release the Job Openings and Labor Turnover Survey for April. JOLTS, as its known, shows the pace of gross job creation throughout the country. Hiring and labor market churn remain significantly depressed, and only slow improvement is expected.