October FOMC: Why the Fed’s struggling to achieve its dual mandate

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The Fed’s dual mandate

The Fed’s dual mandate is balancing inflation with unemployment—that is, achieving both maximum employment and price stability. In order to meet both these long-term objectives, the Fed needs to balance the effect of a monetary move on both inflation and changes in unemployment.

Fed's dual mandate 1

Factors constraining the dual mandate

However, achieving this balance has been difficult to achieve in the past due to the following constraints.

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  • The financial crisis of 2008–2009 led the U.S. economy into a high leverage situation. So the economy needs to deleverage its debt burden first, which seems to constrain the achievement of policy targets.
  • Global risks, such as that posed by the European debt situation, imparts substantial downside to the achievement of monetary policy objectives and may hinder the achievement of targets in the future as well.
  • The Fed’s been tapering its spending on asset purchases, and it’s now at its closure. However, a cut in government spending usually leads to lowering inflation rates in the economy. With the current inflation rate lower than even the target inflation rate of 2%, the restrictive fiscal policy seems quite unclear in its objective.
  • The monetary policy is constrained by the zero-lower bound policy rate. A “zero lower-bound” refers to a situation in which the short-term nominal interest rate is zero, or just above zero, causing a liquidity trap and limiting the capacity that the central bank has to stimulate economic growth.

While the unemployment rate has shown improvement (decreased) after peaking to 10% during the financial crisis of 2008–2009, the inflation rate remains below its long-term target of 2%.

A decline in the unemployment rate suggests improvements in the labor market. This, in turn, boosts consumer spending—all else being equal—and has a positive impact on consumer discretionary stocks. You can gain exposure to the sector by investing in ETFs like the SPDR Consumer Discretionary Select Sector ETF (XLY), the State Street SPDR S&P Retail ETF (XRT), and the VanEck Vectors Retail ETF (RTH). XLY includes the stocks of retailers like Amazon (AMZN) and Nike (NKE) among its holdings.

Next, let’s take a quick look at the current unemployment and inflation rates prevailing in the U.S. economy.

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