Earlier this month, Matthew Yglesias of Slate contended that to combat unemployment, the Federal Reserve should engage in a third round of quantitative easing. “To get our economy back to capacity,” he writes, “the central bank has to tolerate a little bit of price inflation here or there as long as it doesn’t become embedded in a dangerous spiral.”
Aside from the question of whether a QE3 program would actually result in lower unemployment, Yglesias’s column also highlights a particular view on the Fed’s proper role in the nation’s economy. It is one that need not be taken for granted as the best, or only, way to run monetary policy. To understand why this is the case, it is necessary both to comprehend what quantitative easing is, and to revisit the ongoing policy debate over the Fed’s role in our nation’s economic affairs.
Quantitative easing refers to the process by which the Federal Reserve buys Treasury bills and related assets from financial institutions and electronically credits the banks’ reserve accounts. So, although the Fed does not literally print paper money that goes into circulation (risking almost certain inflation), it does “create” money electronically. This boosts the money supply. The expectation is that the banks will lend this newly created money to businesses and industries that, in turn, will hire more workers. Not only does it remain contested, however, whether quantitative easing can be credited for January’s lower unemployment numbers, it is equally unclear whether the theoretical benefits of monetary easing outweigh the potential long-term costs of an expanded money supply to both the United States and other countries in the forms of inflation and higher commodity prices in the developing world.
More fundamentally, however, is the question whether the Federal Reserve should be tasked with adjusting the unemployment rate. The original purpose of central banks was to serve as lenders of last resort for troubled banks. President Wilson signed the Federal Reserve Act in 1913. This established the nation’s central bank, with its primary role envisioned as stabilizing a commercial banking system prone to periodic crises. It was not until the late 1970s that Congress explicitly gave the Fed the dual mandate of maximum employment and price stability. This dual mandate makes it different from the European Central Bank (ECB) whose sole task is price stability.
Congressman Paul Ryan (R-WI) and John B. Taylor of Stanford University have both questioned the wisdom of the dual mandate. The Wall Street Journal correctly noted that the U.S. “spent the end of the 1970s and early 1980s digging out of the mess created by the Fed's effort to boost job creation by printing money.”
Yglesias wants the Fed to do more to lower the unemployment rate. What might be preferable, however, is to leave that task to Congress and to the individual states who can then compete for both business and labor. Perhaps it is time to think differently and consider that the nation’s central bank focus less on unemployment and do what central banks do best: act as a lender of last resort and ensure price stability.
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