About the Fed’s Triple Mandate

Some people seem surprised by Janet Yellen’s comments that give the appearance that she adheres to a triple mandate:

“I pledge to do my utmost to keep that trust and meet the great responsibilities that Congress has entrusted to the Federal Reserve–to promote maximum employment, stable prices, and a strong and stable financial system.”

I don’t really see how this is surprising.  The Fed claims to have a dual mandate – to maintain price stability and promote maximum employment.  But it can really only achieve these mandates if it FIRST maintains a stable financial system.  Make no mistake here.  Janet Yellen is an exceedingly intelligent woman.  She understands the Fed and the Fed’s history like the back of her hand.  And I can assure you that she is uniquely familiar with the Fed’s history.  She knows full well that the Fed wasn’t created to hit employment and inflation targets, but was actually created to support the payments system.  As the Fed has explained:

“By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system.”

The Fed system was created to support the private payments system controlled by the banking system at the time.  In fact, the Fed system is modelled after the New York Clearing House model which was a privately managed clearing house for bank payment settlement that existed prior to the Fed.  After the crisis of 1907 the government got more involved in the process to help oversee and manage the process.  The result of this was the Federal Reserve System which is really just one big payments system attached to the banking system.  Which is another reason why it’s so bizarre that some economists want to “keep banks out of macro” while also focusing on nothing but central banking.  To understand central banking and monetary policy IS TO UNDERSTAND BANKING.

The Fed was created with one primary mandate – to help stabilize the payments system.  And if it doesn’t achieve this goal then it can’t even begin to think about inflation and employment.  Some economists seem to have missed this important fact about the history of the Fed and have instead constructed this mythical world where the Fed hits employment and inflation targets without working with the banking system.  Thankfully, Janet Yellen isn’t in that camp.

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • JK

    Do I sense some Mehrling rubbing off on you? :) I try to read most of what you write and I can’t remember you mentioning Clearing Houses before this post.

  • Stephen

    “to help stabilize the payments system”

    Then if that is really the truth of the matter she might consider that first you would do well to pre-empt instability forming. The Fed track record for that is abysmal. Indeed that is hardly surprising if you also believe in the wealth effect of asset values.

  • Notagain

    somewhat of a surreal post from you …

  • Adam P.

    “The Fed was created with one primary mandate – to help stabilize the payments system”

    Cullen I think there is no one left on this blog who do not agree on this. This is not debatable and so it’s not usefull reading this 2 times a day. WE KNOW IT.

    The question was and still is: “has the FED the power to promote maximum employment and stable prices ?” My answer is a sounding NO. The FED can promote stable prices (and not always), and nothing more.

  • InvestorX

    “The Fed was created with one primary mandate – to help stabilize the payments system.”

    Very simple – split the payment system from the credit system. Then no Fed will be needed (at least for the payment system). So far it can always rely on this hypocritic excuse – “to stabilize the payment system”.

  • InvestorX

    A good point!

  • Cowpoke

    H.R. 1174/S. 238 and S. 215 is legislation currently making the rounds that would change the feds mandate to just One.
    That one being price stability and a side note of inflation targets.
    http://www.fas.org/sgp/crs/misc/R41656.pdf

  • Tom Reilly

    Your quote from the FED is what the FED thinks Congress “intended”, however the Congressional dual mandate does not include that “intent” and the FED does not provide a footnote to where they believe that “intent” is derived.

    The dual mandate is a ruse (OK lets call the mandate some “intent”). The FED is there for the banks and it basically does what it wants as an unelected body with immense power and very little oversight. Essentially they gain (through panic) more unelected power in each crisis so they can be the bail out mechanism for the cycles they themselves create with easy or less easy monetary policy..

    I love when you discuss “intelligence” when discussing FED peeps Yellen or Bernanke. I’d be intelligent too if all I had to was say to the banking cartel “easy money is here to stay”. They are only intelligent as long as the bubbles they create last. Greenspan was genious bf 2008.

  • jt26

    “strong and stable financial system” can have a wide interpretation:
    (a) payments system: ok, since dollar deposits are created there (current)
    (b) moneyness system: i.e. overnight repo markets: probably, but ad hoc currently
    (c) FX cross rates: maybe, short term
    (d) all credit spreads, all credit market liquiidty? other dollar claims (insurance, derivatives etc.)? long term credits (>10 years)? mandate to support junk and unrated paper, shadow banking?
    How far should the Fed go?

  • Geoff

    This post supports the view that banks are the master and the Fed’s role is mainly to serve the banks. One could even take it a step further and say that a clearing house is really just an amalgam of member banks. Therefore, the Fed and the banks aren’t really separate entities. They are one!

    But it is probably misleading to view the banks as one cohesive unit that orders the Fed around. The banks are extremely competitive and, given a choice, a bank would not be interested in bailing out its competitor. Anyone who read the book “Too Big to Fail”, or saw the movie, will know that trying to convince one bank to help another is like pulling teeth.

    So perhaps the Fed is less a slave and more a herder of cats. :)

  • http://orcamgroup.com Cullen Roche

    Yeah, maybe saying the Fed is the slave and the banks are the master is a bit much. They’re partners. The Fed is a middleman to middlemen and they work together to make the system work. It’s about understanding the balance.

  • http://malibuinvests.com Richard

    The Chicago Board of Trade established in 1849, in my opinion, has long been the flagship of the clearing house model. Until the recent Corzine episode, there have been virtually no failures within the commodity clearinghouse systems. For lack of this type of system we can have non-clearing house trades cause such notable failures as the “London Whale” episode. Unfortunately, until we establish a broader use of these systems for financial transactions we are all at risk for further episodes of that type.

  • Anonymous

    She makes Bernanke look like a wing-nut hawk.

  • Dennis

    She looks like a wise white owl. I hope she has a chance to do the dual mandate as well as clear our checks. After we have relentless pounding by ultra right commercials, we might just get lots of female congress folks and then we better get ready to have a country completely run by women. Personally, I can’t wait!

  • Dennis

    I skimmed this paper; it made me nearly barf. “Congress could require an inflation target in [their] statute…there should be penalties for missing the target.” So they want the Citzens United “bought and paid for part of Congress” to control the Fed too!

  • Adam P.

    A very interesting post by Tim Duy about the FED “triple” mandate here:

    http://economistsview.typepad.com/timduy/2013/10/kind-of-a-clown-show.html

    He is the best FED’s watcher in town.

  • A H

    If anything this post isn’t strong enough. A financial stability mandate is structually fundemental to a central banking system, and any other mandates are secondary. This is because the ability of a central bank to influence other economic variables comes from it’s role as a lender of last resort and setter of credit standards.

  • pantmaker

    “One reason that risk premiums may be low is precisely because the environment is less risky.”

    Janet Yellen, July 2007

  • pantmaker

    “If the housing bubble were to deflate, would its effects on the economy be large? No.”

    Janet Yellen, 2005

  • socal

    Dennis, why would it be better if we had a country completely ran by women? I’m not sure i follow your logic here. Are you implying that women are superior to men? I prefer the idea that we’re equal, but maybe that’s old fashioned. She’s never been in the private sector to my knowledge. What possible real world understanding could make her wise? She’s part of the privileged class and she’s in place to follow orders. I guarantee it.

  • Anonymous

    A single mandate would be a catastrophe…already the Fed is an insular, cloistered organization…self-exalting they wouldblove to be accountable only by a singke easily met metric…btw they just about hig zero inflation 2008 to present…ain’t it grand?
    I prefer macroeconomic policy making bodies that target growth…

  • Dennis

    SoCal, Sit down, take it easy, and look at the facts. I said: “After we have relentless pounding by ultra right commercials, we might just get lots of female congress folks and then we better get ready to have a country completely run by women.” Personally I’m sick of the ignorance displayed by the Republicans about economics. The overarching concern about “debt ceilings, Social Security, Medicare and Affordable Heath Insurance” is misplaced. You write “real world”… you’re not in it right now.

  • Dennis

    *Health

  • Dennis

    In 2008 the housing bubble was pricked by the incredible rise in gasoline prices. It popped along with banks that marketed loans and re-fis relentlessly to those that could not afford them during the period 2005-2008. If the private sector were under some sort of control by somebody, then this would not have happened, but as we know the laws in the area were cancelled.

  • pantmaker

    Good read. I agree the FOMC is a clown show of epic proportions. I also don’t hear anyone calling out the Fed’s new found singular mandate which is permanently high equity prices. Every decision, statement and policy they make now is solely about the stock market and keeping it from an inevitable explosion.