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Making Sense of the Federal Reserve

Conducting Monetary Policy - The Dual Mandate

FOMC in plain english

Think about it ...
If inflation has been low and steady at 2 percent per year for many years, you might expect that inflation will remain at 2 percent in the future and plan accordingly. If, however, inflation were 2 percent one year, 8 percent the next, and 12 percent this year, it would be difficult to know how to save, spend, or invest your money.

The second part of the Fed's dual mandate is maximum employment. Maximum employment is the level at which cyclical unemployment—the type that rises during economic downturns—is eliminated. The Federal Reserve has been given the task of using its monetary tools to boost an economy as it starts to weaken.

The dual mandate is a difficult objective because concentration on one variable puts the other at risk. For example, if the Fed were to attempt to drive unemployment to continually lower levels by pressuring interest rates lower and lower, consumers would borrow increasing amounts of money to buy houses, cars, furniture, and vacations. Production could not keep up with the demand for goods, and the prices of those goods would begin to rise—inflation would likely get out of hand. On the other hand, if the Fed were to become overly concerned about inflation and refuse to allow the money supply to expand quickly enough, consumers would buy less and businesses would delay expansion plans. Unemployment would likely rise, perhaps to painful levels.

Back to our car analogy—the dual mandate is like driving on an interstate with a minimum and maximum speed limit. The FOMC's goal is to keep the car—or in this case, the economy—going at a fast, but safe, speed. If the car starts to slow or encounters a hill, the driver may have to give it a bit more gas to maintain speed, but when the car starts to go too fast, the driver will have to ease up on the gas or even tap on the brakes to slow its momentum. In this way, the driver—or, FOMC—must always be mindful of conditions and changes in the road ahead.

Next: How Monetary Policy Works »