The Congressional Roots of the Fed’s New “Evans Rule”

NoNoNoNoThat’s Charlie Evans, president of the Federal Reserve Bank of Chicago, who has been credited as a key force behind today’s somewhat surprising move by the Federal Open Market Committee.  (H/t to Ezra Klein’s twitter feed for the Evans meme.)  Evans has been pushing his colleagues on the FOMC to adopt a specific threshold of unemployment to guide its decisions on when to raise short-term interest rates.  Today, the FOMC essentially adopted an “Evans Rule”: It promised to keep interest rates near zero at least as long as the unemployment rate remains above 6.5%, unless the inflation forecast ticks above 2.5%.  For the first time ever, the Fed now has numerical thresholds for both the level of unemployment and inflation to guide its decisions on raising the Federal funds rate.

Others have already weighed in on the merits of the Evans rule.  I would add two points to this conversation.

First, Wonkblog of course beat me to the punch this afternoon in updating my graphs of opinion movement within the FOMC over the course of the year, as I posted on the Monkey Cage in January, June, and September.  Drawing from the Fed’s release today of FOMC members’ updated economic projections, we can see clearly the evolution of FOMC preferences this year:

The flock of more hawkish members (presumably from the ranks of the Federal Reserve bank presidents, not the Board governors) has dwindled from six participants in January (advocating that the Fed start tightening monetary policy in 2012 or 2013) to just two members today suggesting that the Fed raise rates in 2013.  At the same time, the median of the Fed has shifted towards favoring a longer period of monetary easing—with the overwhelming majority of participants now believing that short term interest rates should be kept near zero until at least mid-2015.  To some degree, these FOMC projections have been superceded by the articulation of an unemployment rate threshold.  The two metrics offer essentially the same information, since the Fed also provides the central tendency of FOMC forecasts of the unemployment rate.  On balance, FOMC participants forecast that unemployment will remain above 6-6.6% until the middle of 2015.  Linking rates to observable economic conditions—rather than a calendar date—presumably provides greater clarity and transparency of the Fed’s decision calculus on raising rates, thus fostering more effective monetary policy.

Second, in addition to heralding Evans’s role, I think we would be remiss if we overlooked the roles played by Augustus Hawkins, Hubert Humphrey, and Henry Reuss on Capitol Hill in the 1970s when they succeeded in pushing the Congress to give the Fed its dual mandate of low inflation and maximum employment.  Very few central banks have multiple mandates; more often, they are charged simply with maintaining price stability.  In the context of the 1970s—with both high inflation and unemployment—a Democratic Congress moved to strengthen its oversight of the Fed—requiring semi-annual reports to Congress and expanding the Fed’s statutory mandate.  The politics of adopting the dual mandate and the Fed’s views about its dual responsibilities both deserve greater attention.  For now, I think it’s fair to argue that one of the most important legacies of the Bernanke Fed will be its effort to take both sides of its mandate seriously. And today certainly marks an important turning point in that evolution.  Bernanke was careful to remind us in his press conference today that the long-term unemployment rate is not driven directly by monetary policy.  And in that sense, the 6.5% threshold is more “guidepost” than “target.”  But after thirty-five years of what some might call the Fed’s benign neglect of its employment mandate (or at least the Fed’s reluctance to even mention unemployment), today’s FOMC’s move is remarkable for what it says about the difficulty Congress faces in trying to shape the priorities of an independent central bank.  And of course, today’s developments should remind us why Republicans are unlikely to accrue any Democratic support for their efforts to strip the Fed of its dual mandate.

[Cross-posted at The Monkey Cage]

Sarah Binder

Sarah Binder is a professor of political science at George Washington University and a senior fellow at the Brookings Institution.