Jerome Powell risks the Fed’s gains against inflation

The big story from today’s Federal Reserve decision isn’t that interest rates are staying the same. It’s that the dual mandate is back. This is bad news for inflation containment if the economy slows down. The Fed should focus solely on inflation. Monetary policy is a poor tool for creating jobs; that’s for entrepreneurs to do.

What is the dual mandate? It means the Fed has two jobs. One is to keep inflation low. The other is to keep employment high. Sometimes these goals contradict. A tighter monetary policy can cut inflation, at the risk of an economic slowdown. A looser monetary policy can stimulate the economy, at the risk of higher inflation. Either way, there’s a tradeoff.

Because of those tradeoffs, the Fed has to choose one mandate or the other. It can’t do both. For the last few years, the Fed has focused on its inflation mandate. Fortunately, the labor market has been historically strong. The Fed was able to take fairly strong measures without sparking recession. It achieved the soft landing a while ago, and the economy remains strong today.

Chairman Jerome Powell is now signaling that the Fed will begin paying attention to its employment mandate again. If the job market slows down, the Fed will be open to more stimulus. This would cause inflation, contradicting its low inflation mandate.

The Fed’s mandate shift is premature. The reason that inflation is still above target is that markets don’t trust the Fed to hold the line on inflation. This week’s announcement does not help rebuild that missing trust.

Nor do people trust either party to restrain government spending, which is the other major cause of inflation. The Fed, by subtly signaling its openness to resuming stimulus, has just hurt its chances of getting inflation back down to its target levels as soon as possible.

The expectations game is more important than this week’s decision to hold interest rates steady. Powell’s signaling a possible interest rate cut at its next meeting on September 18 is the cherry on top of a very bad day for monetary policy.

For more on sound monetary policy, see CEI’s most recent Agenda for Congress.