The Fed has generally not focused on advancing racial equity. Should that approach change? Yes, according to the House majority that recently passed H.R. 2543, the Federal Reserve Racial and Economic Equity Act. President Joe Biden supports the bill, although it 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. H.R. 2543 would add a third mandate: The Fed is to foster “the elimination of disparities across racial and ethnic groups with respect to employment, income, wealth, and access to affordable credit.” The Fed hasn’t had a stellar record in achieving its original mandates, as indicated by the current inflation rate. Achieving a mandate of racial equity would almost certainly be beyond the Fed’s capabilities and would draw it into politics in a way likely to undermine its independence.
For instance, consider the task of eliminating racial disparities in employment. The black and Hispanic unemployment rates have been higher than the white unemployment rate in every month since the Bureau of Labor Statistics began collecting unemployment data by race in 1973. Over the whole period, the black unemployment rate has averaged 11.7%, the Hispanic unemployment rate has averaged 8.7%, and the white unemployment rate has averaged 5.5%. The gaps have persisted even during the current period of very low overall unemployment rates.
Higher black and Hispanic unemployment rates result from a number of related factors including the poor quality of many inner city schools, which leaves some black and Hispanic students poorly equipped with basic job skills; lower high school and college graduation rates, which leaves some black and Hispanic workers unable to meet the minimum educational requirements of many jobs; and blacks and Hispanics being more likely to live in areas where fewer jobs are available.
Can the Fed close racial gaps in unemployment? To achieve its mandate of maximum employment during a recession, the Fed lowers its target for the federal funds rate and engages in quantitative easing: buying long-term Treasury securities and agency mortgage-backed securities. The aim is to reduce borrowing rates for households and firms, thereby increasing spending, gross domestic product, and employment. (Notice that lowering interest rates affects the total level of spending in the economy and the total level of employment.) The Fed has no tools available to improve directly the labor market outcomes of black and Hispanic workers. The factors causing higher black and Hispanic unemployment rates are much better addressed by Congress, the president, and state and local governments through taxing and spending policies.
H.R. 2543 also requires the Fed and other financial regulators to rate financial institutions on their efforts toward diversity and inclusion. In addition to supervising the employment decisions of banks, the Fed would apparently also be required to take into account the record of banks with respect to making loans to black, Hispanic, and LGBT individuals and firms. If banks feel obliged to loosen collateral or other underwriting requirements to expand loans to these groups, the Fed could be overseeing a potential reduction in the stability of the financial system.
Passage of the bill would unavoidably force the Fed to intrude into what are usually considered political matters. Doing so would violate the fundamental bargain that Congress enshrined in the Federal Reserve Act in 1913. Congress intended the structure of the Fed to keep the central bank out of politics. The seven members of the Fed’s Board of Governors serve nonrenewable, 14-year terms. Most legal scholars believe that once a member of the Board of Governors, including the chairman, has been appointed and confirmed by the Senate, the member can’t be removed by the president because of a policy disagreement, only for cause. Because the Fed can fund its operations with revenue from its financial portfolio, it doesn’t rely on congressional appropriations. In return for being allowed to operate independently, Congress intended the Fed to confine its actions to monetary policy, narrowly defined.
The Fed did venture beyond conventional monetary policy in response to the subprime meltdown in 2008 and the COVID-19 pandemic in 2020. During those periods, among other actions, the Fed bought commercial paper and corporate bonds, and it implicitly funded dollar loans to foreign businesses 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’s bargain, fundamentally, the Fed was still engaging in monetary policy. Closing racial unemployment gaps, monitoring banks’ personnel decisions on diversity grounds, and, as part of its supervisory responsibilities, pushing banks to increase loans to black, Hispanic, and LGBT borrowers would require the Fed to achieve political objectives not directly related to monetary policy. H.R. 2543 gives the Fed a new mandate that violates the bargain at the heart of the Federal Reserve Act. It’s unlikely that Fed independence would survive the imposition of this mandate.
Anthony O’Brien is an emeritus professor of economics at Lehigh University.
