Pence: Simplify the Fed's Job

Elisabeth Meinecke

12/6/2010 12:01:00 AM - Elisabeth Meinecke

Despite the Federal Reserve’s announcement last month of a new round of quantitative easing to help unemployment, the national unemployment rate increased to 9.8 percent in November. Indiana’s Rep. Mike Pence, in light of the Fed’s announcement, is promoting a different solution: simplify the Fed’s job so that it doesn’t have to worry about employment.

Pence was among the first to express concerns about the Fed’s employment mandate when news broke last month that the federal government would participate in a U.S. Treasury security-buy, known as quantitative easing.

The news came Nov. 3, a day after historical congressional elections that had most focused on what had happened at the ballot box, not the Fed’s announcement.

“Congress needs to embrace pro-growth fiscal policies to stimulate our economy rather than masking our fundamental problems by artificially creating inflation,” Pence said in a statement released the same day.

The Fed’s move was aimed at keeping interest rates low, but Pence expressed concerned that increasing the money supply at the expense of the dollar’s value was risky.

Pence wants to take away the Fed’s dual mandate, which has been in place since 1977. That year, the Federal Reserve Reform Act gave the government entity a dual task of providing price stability and maximum employment. With a dual mandate, however, the Fed is sometimes required to make decisions that help one mandate but hurt the other. Pence spearheaded legislation in mid-November that takes away the Fed’s responsibility to focus on maximum employment, but the bill is now sitting in the U.S. House.

A Wall Street Journal article Q and A on the topic said the first round of quantitative easing in 2008 and 2009, when the Fed bought Fannie Mae and Freddie Mac securities, was “widely credited with helping to pull the economy out of a freefall by lowering the yields on those securities, pushing down the interest rates for consumer, mortgage and business borrowing.”

Pence argued, however, that the first quantitative easing did not do much to help the Fed achieve its employment mandate.

“Persistently high unemployment—above 9.4 percent for a record 18 straight months—is a testament to the fact that the Fed has not achieved its goal,” Pence said in a letter to colleagues. “I see no reason to expect that QE2 will succeed where QE1 did not.”

“Unfortunately, the monetary policy currently being undertaken is likely to cause more pain with outcomes of high inflation and possibly the creation of another credit bubble,” Pence continued.

Cato Senior Fellow Alan Reynolds said he’s been understanding of the Fed’s moves up until now, and even the first round of quantitative easing, but he thinks people need to realize this is a 2011 economy, not 2008 or 2009 anymore. The gamble of trading off higher inflation for lower unemployment could prove a losing bet.

The primary job of the Fed, Reynolds said, is to protect its product – federal reserve notes – and Reynolds believes a simplified mandate would help.

“To give them [the Fed] conflicting instructions means they can do anything they want,” Reynolds said.

He said that Paul Volcker, while serving as Federal Reserve Chairman, actually told him that a clear mandate would indeed help. Reynolds said Pence’s legislation is on the right track but that the mandate must be specific and detailed to be most effective.