Sign Up

Ben Bernanke, the Law Breaker? The Fed’s “Other” Rate Dilemma

A look at the unconventional policy measures of the Federal Reserve.

August 31, 2015

A look at the unconventional policy measures of the Federal Reserve.

When it comes to the legality of the various unconventional monetary policy measures that have been employed in recent years, it’s the European Central Bank that has got most of the attention.

Look more closely, though, and it’s the Fed that you might want to be more concerned about and particularly if the latest China-related market hiccup causes it to delay its first policy tightening any further.

The last time unconventional policy was undertaken by the Fed – by Paul Volcker — it was dropped right before the ’82 elections and hence under strong political pressure.

“It is my judgment that the law has, from time to time, been conveniently ignored,” said an irate Senator at hearings on the operating performance of the Fed. It wasn’t a recent accusation, I’ll grant you.

The Senator in question was Hubert Humphrey, and the date was 1976. Two years later, the result of his and others’ deliberations was the Full Employment and Balanced Growth Act, more commonly known as the Humphrey-Hawkins Act.

Among the changes it brought about, one was to the Fed’s monetary policy mandate in the form of Section 2A of the Federal Reserve Act, which subsequently (and to this day) reads as follows:

    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.

Decoding the mandate

On first inspection, it’s an innocuous looking sentence. “Maximum employment, stable prices,” the famous dual-mandate. However, what about the bit on “moderate long-term interest rates.” It is difficult to realize that it is even there.

But what does one think about the idea of long-term interest rates as having been “moderate” in recent years? Have they really been so? Actually, they have been extraordinarily low, particularly in comparison to the size of the fiscal deficit and the U.S. national debt.

Indeed, the precise goal of more than one of the unconventional monetary policy measures enacted in recent years was to ensure that long-term interest rates were anything but “moderate.”

That’s not the only potential problem. What about the stipulation to “maintain long-run growth of the monetary and credit aggregates?” Has there been any mention of the monetary and credit aggregates in recent years? Not really.

No mention of money supply

In fact, in its latest Monetary Policy Report, there is not a single mention of the terms “M1” or “M3,” only two of “M2,” and not a single forecast of a monetary or credit aggregate in sight.

Not only did the Fed stop publishing targets for the monetary aggregates back in 2000, but it also stopped calculating and publishing one of the key monetary aggregates altogether in early-2006.

Remember M1, M2 and M3? Well, as of 2006, there was no more M3. That was a pity – it turned out – because it signaled that monetary policy was significantly too easy at the time.

And in a 2009 Fed staff presentation on inflation, the only mention of the money supply was in a slide entitled, “we had to say something or Milton Friedman would have been very angry.”

Actually, Mr. Fed staff economist, you were supposed to be analyzing the money supply not because of Milton Friedman, but because it’s the law.

Moreover, that stipulation about “stable prices” isn’t what the Fed’s self-imposed 2% inflation target equates to at all.

Bernanke’s interest in interest rates

Coming back to that problem of “moderate long-term interest rates,” former Fed Chairman Ben Bernanke has been rather quiet of late on the subject of economics. But was quite the blogger for at least a couple of weeks back in April. Three of his first four posts were on the subject “why are interest rates so low?”

Ben Bernanke could not have been just idly blogging away on whatever he happened to read about in that morning’s Wall Street Journal.

It seems like he was blogging furiously about low interest rates because somebody had whispered in his ear that it was something of a legal weak-spot in the policies undertaken during his chairmanship of the Fed.

When it comes to U.S. monetary policy, the Fed needs to listen to Federal Advisory Council, a body mandated under Section 12 of the Federal Reserve Act.

It needs to to meet with the Board of Governors four times per year with respect to banking and monetary policy-related issues (the CEOs of Wells Fargo, Morgan Stanley & Comerica are among its current members).

Here are a couple of excerpts from the latest Committee meeting in May:

Council members believe that the normalization of monetary policy does not need to wait for both sides of the Federal Reserve’s dual mandate to be fully satisfied

The current zero bound rate level was initiated as an emergency response to the crisis of the recession. We are no longer in a crisis environment, and a crisis level of rates is no longer warranted

Asset prices are being heavily influenced by the low interest rate environment and might tend to stray from fundamental value if policy remains too easy for too long

The impact of long-term near-zero interest rates has potentially played out its effectiveness

Prediction for what’s to come

Come September, my suspicion is that the Fed will raise interest rates.

It’s not that China or Europe isn’t a concern, but I do wonder about the Fed getting itself into difficulties with the U.S. Congress if it continues its policy of zero interest rates, despite the fact that its price and employment objectives have both been virtually met.

When I say I worry about the Fed getting into “difficulties” with Congress, I mean it getting into “even more difficulties.” After all, it already has its hands rather full with respect to community banking, leaking of highly confidential information, audit rights, and a new Taylor rule of some sort, not to forget the rather important election season directly ahead.


ECB gets most attention when it comes to the legality of the unconventional monetary policy measures.

It would be a matter of concern if the Fed delays policy tightening due to the China market hiccup.

The Fed might get itself into trouble with Congress if it continues its policy of zero interest rates.

Fed's mandate concerns maximum employment, stable prices and moderate(!) long-term interest rates.

Bernanke blogged about low interest rates because it was a legal weak-spot during his Fed chairmanship.