Will a racial equity mandate end the independence of the Fed?
The Fed has generally not focused on promoting racial equity. Should this approach change? Yes, according to the House majority that recently passed HR 2543, the Federal Reserve Racial and Economic Equity Act. President Joe Biden backs the bill, even though he faces an uncertain prospect in the Senate.
The Federal Reserve Act, as amended in 1977, gives the Fed a dual mandate of maximum employment and stable prices. HR 2543 would add a third mandate: the Fed must promote “the elimination of disparities among racial and ethnic groups in employment, income, wealth, and access to affordable credit.” The Fed hasn’t had a stellar record in delivering on its initial mandates, as indicated by the current inflation rate. Achieving a racial equity mandate would almost certainly be beyond the Fed’s abilities and drag it into politics in a way that could undermine its independence.
For example, consider the task of eliminating racial disparities in employment. Black and Hispanic unemployment rates have been higher than the white unemployment rate every month since the Bureau of Labor Statistics began collecting unemployment data by race in 1973. Over the entire period , the black unemployment rate averaged 11.7%, the Hispanic unemployment rate averaged 8.7%, and the white unemployment rate averaged 5.5%. The gaps have persisted even during the current period of very low overall unemployment rates.
Higher black and Hispanic unemployment rates are the result of a number of related factors, including the poor quality of many inner-city schools, which leaves some black and Hispanic students ill-equipped with basic job skills; declining high school and college graduation rates, which prevent some black and Hispanic workers from meeting the minimum education requirements of many jobs; and blacks and Hispanics being more likely to live in areas where fewer jobs are available.
Can the Fed Bridge Racial Gaps in Unemployment? To achieve its maximum employment mandate in a recession, the Fed lowers its federal funds rate target and engages in quantitative easing: buying long-term Treasuries and mortgage-backed securities of agencies. The goal is to reduce borrowing rates for households and businesses, thereby increasing spending, gross domestic product and employment. (Note that lowering interest rates affects the total level of spending in the economy and the total level of employment.) The Fed has no tools to directly improve workers’ labor market outcomes. blacks and Hispanics. The factors driving higher unemployment rates among Blacks and Hispanics are much better addressed by Congress, the President, and state and local governments through tax and spending policies.
HR 2543 also requires the Fed and other financial regulators to evaluate financial institutions on their diversity and inclusion efforts. In addition to overseeing banks’ employment decisions, the Fed would apparently also be required to consider banks’ track record when it comes to lending to Black, Hispanic and LGBT individuals and businesses. If banks feel compelled to relax collateral or other underwriting requirements to expand lending to these groups, the Fed could oversee a potential reduction in financial system stability.
Passage of the bill would inevitably force the Fed to meddle in what are generally considered political matters. This would violate the fundamental market that Congress enshrined in the Federal Reserve Act in 1913. Congress wanted the structure of the Fed to keep the central bank out of politics. The seven members of the Fed’s Board of Governors have a non-renewable term of 14 years. Most jurists believe that once a member of the Board of Governors, including the President, has been appointed and confirmed by the Senate, the member cannot be removed by the President due to political disagreement, only for a valid reason. Because the Fed can finance its operations with revenue from its financial portfolio, it is not dependent on appropriations from Congress. In exchange for being allowed to operate independently, Congress wanted the Fed to limit its actions to monetary policy, strictly speaking.
The Fed ventured beyond conventional monetary policy in response to the subprime mortgage meltdown in 2008 and the COVID-19 pandemic in 2020. During these periods, among other actions, the Fed bought commercial paper and corporate bonds, and it implicitly funded dollar loans to foreigners. companies by establishing liquidity swap lines with foreign central banks.
Although the Fed’s actions in 2008 and 2020 may have strained the terms of the Federal Reserve Act agreement, fundamentally the Fed was still committed to monetary policy. Closing racial unemployment gaps, monitoring bank staff decisions for diversity reasons and, as part of its oversight responsibilities, pushing banks to increase lending to black, Hispanic and LGBT borrowers would force the Fed to reach policy objectives not directly related to monetary policy. HR 2543 gives the Fed a new mandate that violates the market at the heart of the Federal Reserve Act. The independence of the Fed is unlikely to survive the imposition of this mandate.
Anthony O’Brien is Emeritus Professor of Economics at Lehigh University.