A Politicized Fed Is the Law of the Land

Everyone knows the Federal Reserve has a dual mandate: maintain full employment and stable prices. But what everyone knows just ain’t so. The Fed has a third mandate that never gets mentioned: achieve moderate long-term interest rates. The political stakes of this neglected plank are likely to become much higher than today.

The 1977 Federal Reserve Reform Act created the modern Fed’s triple mandate. After more than a decade of chaotic inflation, which finally abated during the 1980s, economists, policymakers, and financial commentators implicitly agreed that the Fed should pursue interest rate stability indirectly. Central bankers interpreted “moderate interest rates” to mean whatever rates were consistent with the Fed’s price stability and employment goals, which were widely believed to be more important and more controllable.

The “gentlemen’s agreement” of subordinating interest rates to jobs and prices may soon come to an end. The federal government will likely run huge deficits for the next ten to 20 years, pushing up borrowing costs. The Congressional Budget Office projects a deficit of $1.9 trillion in 2025, rising to $2.7 trillion in 2035. Federal debt held by the public would rise to 123 percent and 135 percent of GDP, respectively. Real interest rates have risen in recent years and, given Uncle Sam’s increasing demands for scarce capital, will likely continue to do so.