Question 1

What is the Fed's dual mandate?

Accepted Answer

Congress gave the Federal Reserve two jobs in the 1977 amendments to the Federal Reserve Act: stable prices and maximum employment. A third goal, moderate long-term interest rates, is usually folded into the other two because if you hit stable prices and maximum employment, long rates take care of themselves. The Fed picks one number for each side. The inflation target is 2% on core PCE, stated explicitly since 2012. The employment target is whatever the labor market can sustain without setting off wage inflation, currently estimated around 4% on the unemployment rate. Two mandates, one policy rate. That is the tension.

Question 2

What is the target inflation rate?

Accepted Answer

Two percent, measured on personal consumption expenditures. The Fed picked that number in 2012 after twenty years of unofficial targeting at roughly the same level. Two is not a magic number. It is low enough that most consumers do not notice it, high enough to keep the economy away from the zero bound where monetary policy stops working. Headline CPI runs about 0.3 percentage points above PCE on average, which is why the chart above uses CPI and the target band is drawn a bit wider than the explicit 2%. The Fed averages over time, so one quarter at 3% does not trigger a policy response. A year at 3% does.

Question 3

What is the natural rate of unemployment?

Accepted Answer

The lowest unemployment rate the economy can hit without wages and prices starting to spiral. Economists call it U-star, or the non-accelerating inflation rate of unemployment. It is not directly observable. You estimate it from how wages and prices behave at different labor market tightnesses. The Congressional Budget Office and the Fed's Summary of Economic Projections both put the current natural rate around 4%. That number moves. Aging demographics, labor force participation, and productivity all shift it. In the late 1990s the natural rate was thought to be around 5.5%, and then unemployment fell to 4% with no wage spiral and the economists had to revise. That is how it works.

Question 4

What is the Phillips curve?

Accepted Answer

A 1958 paper by A.W. Phillips that showed a negative relationship between unemployment and wage growth in the UK going back a century. When jobs got scarce, workers got raises. When jobs got plentiful, wages stalled. The macro version replaces wages with prices and gives you the short-run trade-off the Fed actually faces: push unemployment below the natural rate and you get inflation, tolerate unemployment above the natural rate and you get disinflation. The curve is noisy, shifts around with expectations, and famously broke down in the 1970s when you got both at once. But the basic trade-off still anchors how the Fed thinks about what rate cuts and rate hikes actually do.

Question 5

What happens when the mandates conflict?

Accepted Answer

The Fed picks one. In 2022 inflation was running above 9% and the unemployment rate was under 4%. The Fed hiked from zero to 5.5% in eighteen months. They picked inflation. Jobs slowed but the recession did not show up, which the Fed will take as a win. In 2020 the pandemic crashed employment to 14.8% in April and inflation briefly turned negative. The Fed cut to zero, ran quantitative easing, and kept policy loose for two years. They picked jobs. The picking is not explicit. The chair never says we are throwing the other half under the bus. You just watch which number moves in the statement and which one stops getting mentioned. That tells you.

The Fed's dual mandate, in tension.

Inflation vs. unemployment, 2021 Q2 to 2026 Q1

The dual mandate, answered.

The Fed's dual mandate, in tension.

Inflation vs. unemployment, 2021 Q2 to 2026 Q1

The dual mandate, answered.

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