How Low? Too Low

How Low? Too Low

John Lim  |  September 27, 2019

IT’S WIDELY assumed that the Federal Reserve, our nation’s central bank, has two mandates: maximum employment and stable prices. But a closer look at the Federal Reserve Act of 1977 on the Federal Reserve’s very own website reveals a third mandate, namely “moderate long-term interest rates.”

Does a 1.7% yield on 10-year Treasurys and 2.15% on 30-year Treasurys count as “moderate long-term interest rates”? Since I have nothing better to do on the weekend, I headed to the Federal Reserve Bank of St. Louis’s website to see what the average long-term yields have been since the Federal Reserve Act of 1977 passed. The answer: 6.2% for the 10-year Treasury and 6.75% for the 30-year Treasury.

The Federal Reserve is doing much better on the employment front, with the unemployment rate hovering around 3.7% lately. And it certainly seems like prices are stable, with both the Fed’s favorite inflation metric and inflation expectations hovering around 1.6%. I guess two out of three isn’t bad.

But getting back to the Fed’s third mandate: Is it really a mandate and, if so, does it really matter? To answer the first question, I consulted Prof. Google. I typed “Federal Reserve and moderate long-term interest rates“ into the search box. The top five search results linked to official Federal Reserve websites.

A site run by the Federal Reserve Bank of Richmond tersely states: “The third goal—’moderate long-term interest rates’—is often not explicitly discussed.”

According to the Federal Reserve Bank of San Francisco, “These dual policy goals [maximum employment and low stable inflation] imply moderate long-term interest rates.” Talk about a non-mandate mandate.

It’s worth noting that the Fed has much less control over long-term interest rates than short-term rates, hence the predictive power of the yield curve.

 If so, why include the third mandate in the 1977 Federal Reserve Act? I suspect it was included because the 1970s were a period when inflation began to spiral out of control. This led to very high interest rates, with the 30-year Treasury eventually peaking at 15% in 1981.

If inflation and inflation expectations are under control, as they have been for decades, long-term interest rates will likely be contained. But what about excessively low long-term rates? Does the Fed have a duty to prevent long-term interest rates from getting too low?

Based on the actions of the Federal Reserve in recent years, the answer is an unequivocal “no.” The post-Great Recession quantitative easing and zero interest rate policy took aim not just at short-term rates, but also at long-term rates, dragging both lower.

As recently as 2016, Ben Bernanke discussed the explicit targeting of long-term rates as a viable tool for the Fed. With a recession on the horizon and interest rates already so low, it’s certainly possible—and maybe even probable—that long-term interest rates will soon be targeted again and pushed even lower, perhaps to zero or below, with the goal of spurring economic growth.

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