Legislating Policy Rules Hurts in Times of Crisis

May 1, 2015

Orange, CA — Legislating that a central bank follow a strict set of operational mandates restricts its freedom to react in crises and limits “the discretionary decision making” of the Fed, said one of its top officials on Friday.

Speaking at Chapman University in Orange, California, John C. Williams, CEO and president of the Federal Reserve Bank of San Francisco, addressed legislative proposals seeking to mandate that Fed decisions follow pre-set policy rules. While those rules have proven an “invaluable tool for research and practical policy considerations at central banks,” Williams said that the Fed’s flexibility would be constrained by their legislatively mandated use, particularly in unpredictable economic circumstances and crises.

Describing what he called “the independence dilemma,” Williams laid out the two approaches to central banks’ independence. He juxtaposed the old models of “operational mandates,” which assign a rule for central banks to follow and restrict their flexibility—such as the gold standard and fixed exchange rates—and “goal mandates,” which require meeting overall economic goals, such as the Fed’s dual mandate of maximum employment and price stability. Operational mandates had ultimately failed, he said, while goal mandates—the model under which the Fed has operated since the Federal Reserve Reform Act of 1977—have proven much more successful.

Matthew Schiffgens
Federal Reserve Bank of San Francisco
(415) 974-3246

The Federal Reserve Bank of San Francisco, with branch offices in Los Angeles, Seattle, Salt Lake City, and Portland, and a cash processing office in Phoenix, provides wholesale banking services to financial institutions throughout the nine western states. As the nation’s central bank, the Federal Reserve System formulates monetary policy, serves as a bank regulator, administers certain consumer protection laws, and is fiscal agent for the U.S. government. Follow us on Twitter at twitter.com/sffed.