Price stability is more than enough for the Fed — no new mandates


It’s no secret that the Fed is having a hard time controlling inflation. While it is failing at its primary duty, the Democrats are busy crafting executive orders, passing bills and proposing new legislation that will expand the list of goals the Fed must prioritize. 

As it stumbles to meet its current mandates to maintain price stability, maximum employment and financial stability, Congress and the administration are asking it to also control greenhouse gas emissionspromote equal employment, income, wealth and affordable credit outcomes across racial and ethnic groups, and proposing that the Fed be required to issue a new central bank digital currency. This insanity must stop. The Fed already has too many conflicting mandates without adding new highly politicized ones. The Fed should focus on price stability.

In October 2021, dutifully complying with a May executive order, the Financial Stability Oversight Council (FSOC) issued a report claiming that climate change poses a systemic risk to the financial system. To counteract this risk, the FSOC proposed that its members, including the Federal Reserve System, “incorporate climate-related financial risk into their regulatory and supervisory activities.” The FSOC’s primary regulatory tool for accomplishing this is a, “scenario analysis conducted by regulators to measure risk across a broad set of institutions.”

Scenario analysis is a purely hypothetical modeling exercise where institutions have to simulate their profits and losses assuming some calamitous event occurs in the future. Financial regulators would specify the fictitious calamitous event as they do today in the stress test exercises the Fed imposes annually on large bank holding companies.

In the case of climate-change risk assessment, the scenario would involve a so-called transitional risk event where some unknown climate-change scare causes Congress to pass new laws negatively impacting greenhouse gas-intensive firms, or consumers to abandon activities that use fossil fuels. In these fictional scenarios, the impact of imaginary events inflicts severe distress on greenhouse gas-intensive firms, elevating their default risk. This purely conjectural default risk will trigger higher capital requirements and other regulatory restrictions for the financial institutions that own their debt or equity resulting in a higher cost and more limited access to capital for greenhouse-intensive firms.

Hypothetical scenario analysis was the basis for the FSOC’s global systemically important institution designation of Metlife, Inc. in 2014. The designation subjected Metlife to the Dodd-Franck Act’s enhanced prudential regulatory standards that applied to the largest U.S. bank holding companies. Metlife fought the designation in court and won arguing that the FSOC hypothetical scenario analysis had no basis in history or fact. As such, it was a violation of the arbitrary and capricious standard imposed by the Administrative Procedures Act. Climate-change scenario analysis will be based on scenarios that are purely imaginary with no basis in history and should be ruled illegal if courts follow the Metlife precedent.

On June 21, the House passed H.R. 2543, the Federal Reserve Racial and Economic Equity Act. The act requires that the Federal Reserve,” must carry out its duties in a manner that supports the elimination of racial and ethnic disparities in employment, income, wealth, and access to affordable credit.” The law applies to the Fed’s conduct of monetary policy, supervision and regulation of banks, thrifts, financial institution holding companies, systemically important financial institutions and financial market utilities designated by the FSOC. The Fed must report to Congress periodically on the steps it has taken and on its pending plans to achieve these new mandates.

The Fed should be tasked with promoting equal opportunity for all but a mandate to engineer equal outcomes is not compatible with our capitalist system — it is socialism, pure and simple. Policies that mandate the politically charged “equity and inclusion” agenda of the progressive left are a direct affront to the Fed’s independence to conduct a monetary policy in a manner that promotes price stability and maximum employment.

The proliferation of Fed mandates does not end there. Democrats are promising new legislation that will require the Fed to issue a central bank digital currency. Rep. Jim Himes (D-Conn.) recently released a “white paper” outlining the characteristics of the digital currency the Fed will be required to issue in legislation yet to be introduced. Himes envisions requiring the Fed to issue an intermediated retail digital currency, meaning that financial institutions and other qualified entities would be the customer interface for their digital wallets. These intermediaries would be responsible for satisfying anti-money laundering “know your customer” regulations and for clearing and settling digital currency transactions using some type of secure limited access blockchain ledger system. These intermediaries would presumably also develop innovative financial accounts and services to attract customer balances.

The Himes vision of a mandatory Fed digital currency is badly misguided. The idea that it would make payments freely available to those currently unbanked is nonsense. All payments systems charge fees to process transactions, and distributed ledgers — at least the ones in use today — are very expensive. The Bitcoin blockchain requires more electricity than the entire country of Argentina to process its digital transactions — and Bitcoin miners earn enough to cover electricity costs and earn a return on their mining rigs. Moreover, as I explain here, federally insured financial institutions could create tokenized deposit accounts insured up to the $250,000 FDIC insurance limit. These digital deposits could be designed to provide exactly the same services and meet the criteria and benefits envisioned by representative Himes without requiring the Fed to issue a new retail digital currency.

It’s no longer Federal Reserve mission creep, it’s a sprint, and it’s no joke. At a time when the Fed has failed to keep inflation in check, assigning it more mandates, especially ones as politically charged as combating climate change, implementing an “equity” agenda, and designing and issuing a new retail Federal Reserve digital dollar would guarantee it fails on its primary task of achieving price stability with maximum employment. The Fed already has too many mandates. It should focus on price stability. 

Paul Kupiec is a senior fellow at The American Enterprise Institute specializing in banking and financial services issues.


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