In 2021, prices in the United States and across the globe rose rapidly, reintroducing a concern that had lain mostly dormant in U.S. politics since 1982: inflation.1 Inflation is when the price of goods and services increases over a given period of time; in other words, it costs more money to buy the same amount of eggs, milk, transport, and so on.
Political leaders, however, did not attempt to respond primarily with legislative or executive action.2 Instead, the Federal Reserve (Fed), an administrative agency in charge of monetary policy with a two-percent inflation-rate target, responded.3 In March 2022, the Fed began to raise interest rates, eventually up to five percent.4 Today, the conventional wisdom of Fed officials5 and scholars6 is that the Fed generally must always respond to inflation, no matter its causes. That view is driven in part by section 2A of the amended Federal Reserve Act,7 which establishes a dual mandate to pursue “stable prices” and “maximum employment.”8 But this interpretation is wrong.
In full, section 2A states that the Fed “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”9 The text directs the Fed to regulate the level of money and credit10 so they are “commensurate with the economy’s long run potential.”11 In contrast, the conventional dual-mandate interpretation focuses on the latter clause to argue the Fed should regulate inflation at large, ignoring this first part of the sentence.12 But read correctly, section 2A says the Fed has a sole mandate to regulate credit.13
The Fed should act to limit credit with the tools that Congress has given it.14 Credit is borrowed money, which a borrower can use to buy more goods or services than they otherwise could buy using only their existing income or savings.15 If banks extend too much credit, borrowers will use the extra money to spend more, raising aggregate demand and causing sellers to raise prices.16 If banks lend to borrowers who cannot repay their debts, even if such borrowers do not spend the extra money, financial instability can follow. But if non-credit-based forces, like supply-side shocks, affect price levels, the Fed should not act.
By focusing on inflation at large, the Fed has reinterpreted its statutory mandate without congressional authorization. In focusing on inflation in all its forms, the Fed ignores economist Milton Friedman’s warning that it cannot “control directly the price level” effectively.17 This interpretation also has political economy implications. As Professors Joseph Fishkin and William Forbath note, economic prosperity is not solely a “technical optimization problem that can be solved using scientific tools alone,” but rather a broader “political economy” problem involving “choices about the distribution of wealth, power, and opportunity.”18 Thus, in the Fed’s early history, officials such as Federal Reserve Bank of New York Governor Benjamin Strong opposed assigning the Fed a price stability mandate.19 He warned it would be “undemocratic” and “contrary to the spirit of American institutions” to “delegate[] avowedly and consciously [a] vast power of responsibility for price fixing to a small group of men who, in an economic sense, might come to be regarded as nothing short of a super-government.”20 Even if one does not fully agree with Strong’s aversion to a broad interpretation (and regardless of its objective desirability), surely it is worse for the Fed to self-delegate this power than for Congress to do so explicitly.
Part I will examine the Fed’s history of regulating credit, repudiating the idea that the Fed has ever been solely responsible for regulating total price levels. When Congress wrote the mandate in 1977, then–Fed Chair Arthur Burns claimed it did not deviate from existing policy.21 While the Act’s text seems obtuse, it is not unprecedented: Even in 1923, the Fed saw its job as “limiting the volume of credit . . . to such amount as may be economically justified — that is, justified by a commensurate increase in the Nation’s aggregate productivity.”22 In 1951, it used similar language.23 Both times, the Fed repudiated sole responsibility for controlling price levels, citing other policy alternatives.24 Looking at how the President and Congress have empowered the Fed also provides clues about the mandate’s purpose. While the Fed is most famous for its interest-rate policy, it never solely used that tool.25 In fact, from 1941 to 1951, it did not even adjust rates to affect credit levels.26 Instead, at various times, it regulated the terms and conditions of credit for stocks, consumer goods, and real estate.27 While “selective” credit regulations are downplayed as a policy tool today,28 prior Feds thought that it was critical to regulate the quality of credit to also regulate its quantity.29
Part II argues that the Fed’s shift under Chair Paul Volcker to regulate broader inflation exceeded its statutory mandate. As Professor Christina Parajon Skinner warns, central banks risk acting ultra vires when they try to address “economic problems that require solutions that sit beyond or outside the Fed’s legal mandate.”30 In 1979, Chair Volcker let interest rates soar to over twenty percent to lower high inflation.31 Although his actions put millions out of work, Volcker is also credited for ending a nearly two-decade-long inflation.32 Even if one agrees with the result ex post, at the time many thought that inflation had come from supply-side factors.33 If the Fed’s mandate is actually to regulate inflation only if credit is responsible, the Fed, as an agent of Congress, acted beyond its statutory authority by tackling a broader issue that it was not tasked to fix alone.
Part III uses two examples to illustrate how the Fed should act under a credit mandate. It should respond when there is too much credit, even if there is not general inflation. But it should not respond if the price level changes due to noncredit factors. A brief conclusion then follows.
I. The Fed as Credit Regulator
This Part argues that the Fed’s original mandate is to regulate credit. This can be shown both by how Fed officials saw their role and by how Congress empowered the Fed. While the Fed executes monetary policy today mostly by setting interest rates,34 it has used regulation before to stem excessive credit in specific parts of the economy to prevent such credit from hurting the economy’s long-run potential. Each time, the Fed saw this regulation as consistent with its broader mandate. Notably, it never selectively regulated credit to target price-level changes from outside of the credit system. Tracing the Fed’s history from 1913 to 1977 (when the mandate was codified) shows this continuity.
A. Real Bills Doctrine (1913–1932)
From the beginning, Congress specifically granted the Fed the power to (try to) regulate credit lent by banks.35 The Fed was born in 1913 from the ashes of a banking crisis.36 Congress believed that if credit was lent only to productive uses, future bank crises could be avoided.37 Under section 13 of the Act, the Fed could lend against only commercial paper for “agricultural, industrial, or commercial purposes”38 (“real bills doctrine”39). By tying loans to “real” activity, proponents of the real bills doctrine thought such loans would not lose value and thus banks would stay solvent.40 They assumed banks wanted access to the Fed, not risking losing access by lending elsewhere.41 Under section 14, the Fed could buy or sell discount commercial paper to “accommodat[e] commerce and business.”42 Citing sections 13 and 14 of the Act in a 1923 annual report, the Fed discusssed its responsibilities as limiting (1) credit to “productive purposes” and (2) “the volume of credit . . . to such amount as may be economically justified — that is, justified by a commensurate increase in the Nation’s aggregate productivity.”43 The Fed even noted that limiting the former was sometimes necessary for the latter.44 In effect, the Fed would regulate banks, similar to how the Interstate Commerce Commission (ICC) regulated railroads.45
Stock speculation illustrates how the Fed saw its role as managing credit, not price levels. In 1918, as it became clear that the United States and its allies would win World War I, investors became exuberant.46 Believing stock prices would grow, investors borrowed more and more to buy stocks.47 As stock prices rose, stocks were worth more than the debt used to buy them, making them theoretically less risky. But the party only lasted if stock prices grew. If prices fell, stocks could be worth less than the loans, risking bank instability. During the war, the Fed was briefly given wartime powers to limit stock credit, creating margin requirements that let stock investors borrow only if they set aside a certain amount of cash.48 While some officials, like Governor Strong, essentially the “de facto leader of the entire [Fed],”49 thought they worked well, Congress failed to authorize them during peacetime.50
After the war, without restrictions, the stock market became “a mania for speculation.”51 The Fed argued that “speculation in corporate stocks and securities [should] be restricted.”52 And Governor Strong noted: “Our job is credit.”53 But the Fed was limited in what it could do. Banks, at least when asset prices rose, did not care about access to Fed lending.54 While the Fed could buy or sell government debt (Treasuries) to “increase or decrease the quantity of base money,”55 affecting overall debt costs (“open market operations”),56 it could not stop problematic credit coming from just one sector. If the Fed raised rates, making borrowing costly, it would not only deter stock lending, but all commercial lending.57 Strong argued that, while “critics damn us vigorously and constantly for not tackling the stock speculations,” the tough question was “what . . . the consequences of” raising rates would be.58
In fact, even without its tailored wartime powers, the Fed still tried to convince banks to lower their lending for stocks. The Fed even wrote to each of the banks that it supervised that growing “the current volume of speculative security credit . . . is not in harmony with the intent of the Federal reserve act.”59 The letter failed, and by 1929 banks had only funded a quarter of the debt for stock purchases.60 As things worsened, the Fed resorted to raising interest rates.61 While this slowed stock borrowing, it also inhibited borrowing overall, slowing economic activity right before the Great Depression.62
During this period, the Fed’s focus was on speculative credit, not the price level. When the Fed raised rates in the late 1920s, price levels were mostly flat and the money supply grew at only a modest rate, but credit had spiked.63 And in 1928, when Congress tried creating a price stability mandate, most Fed officials and staff opposed it.64 As the Fed itself noted, “price fluctuations proceed from a great variety of causes, most of which lie outside the range of influence of the credit system.”65
B. Rise of Selective Credit Regulation (1933–1951)
While the mid-1930s is viewed as a rebirth of the Fed,66 the era did not signal a shift away from the Fed’s role as credit regulator. After the Great Depression, Congress changed the Fed in several significant ways, including changing its legal structure.67 But the key takeaway was that the Fed should respond more “timely as well as in the right direction if credit policy [were] to [be most] effective[].”68 While many members of Congress thought the Depression had several potential causes, they saw “the excessive flow of credit into the stock market” as a major one.69
Instead of weakening the Fed, Congress, in 1933, gave the Fed new directives, stating that “all purchases and sales . . . shall be governed with a view to accommodating commerce and business and with regard to their bearing upon the general credit situation of the country.”70 The revised Act not only told Federal Reserve banks to give credit to banks “as may be safely and reasonably made with due regard for the claims and demands of other member banks,” as stated in the 1913 Act,71 but also with due regard for “the maintenance of sound credit conditions, and the accommodation of commerce, industry, and agriculture.”72 The Securities Exchange Act of 193473 also empowered the Fed to restrain credit directly via margin requirements,74 the same tool that Congress failed to grant after World War I.75 Unlike the Fed’s open-market operations, which influence all credit, margin requirements act selectively by targeting borrowing for stocks.76 This new tool also “coincided” with the removal of the real bills doctrine.77 One Fed Governor noted that this tool “was in line with various provisions of the Federal Reserve Act” because it also “restrict[ed] the use of credit for speculative purposes.”78
In addition, the Fed continued to insist during this period that “[p]rice stabilization [was] not an adequate objective.”79 While acknowledging “[t]hat wide fluctuations in the price level” could be “disastrous,” the Fed argued that “price stability should not be the sole or principal objective of monetary policy.”80 To accomplish price stability, the Fed needed “the cooperation of other agencies.”81 Inversely, even when “the price level remain[ed] stable,” excessive credit could still cause “unstable economic conditions” that the Fed should address.82
The Fed’s original role as a credit regulator is further demonstrated by its regulation of credit for consumer goods, like appliances, cars, and furniture (“consumer credit”). Until 1941, the Depression led to weak aggregate demand.83 But leading up to World War II (WWII), policymakers worried that consumer credit could “stimulate demand for consumers’ durable goods,” diverting “materials, skills, and equipment needed for national defense.”84 In response, President Franklin Roosevelt issued an executive order under the Trading with the Enemy Act85 (TWEA), authorizing the Fed to selectively regulate consumer credit.86 The Fed required consumer credit to satisfy certain downpayment and maturity requirments (“Regulation W”).87
During WWII, the Fed used Regulation W for monetary policy. The Fed could not use open-market operations because the U.S. government wanted to keep Treasury rates low.88 The Fed had agreed to buy Treasuries at full price, so it could not buy or sell Treasuries to influence credit.89 Some claim that the Fed had “abdicat[ed] . . . control over the supplies of money and credit.”90 In reality, the Fed used Regulation W to compensate for “the diminished influence . . . of traditional central banking instruments.”91 Some mused that Regulation W could become “a permanent instrument of credit regulation”92 when other tools were “wholly or largely inapplicable.”93 At the same time, the Fed thought that it should not play the main role in fighting inflation,94 deferring to wage and price controls and tax policy instead.95
The Fed considered Regulation W to be a success. In 1942, consumer credit growth fell fifty percent the first year it was implemented.96 After other wartime wage and price controls were lifted, the Fed warned that prior monetary policy tools would not be enough, especially since the Fed was still supporting Treasury debt.97 From 1945 to 1947, it sought “permanent authority” to regulate consumer credit,98 arguing it could be “integral” to “maintaining sound credit conditions.”99 But the Fed failed to get public support.100 Retailers, in particular, opposed Regulation W.101 In 1947, Congress deauthorized Regulation W.102
But this deauthorization was short-lived. In 1948, Congress reinstated these credit controls.103 Then, in 1950, given fears that the Korean War would raise demand again for industrial goods and labor, Congress let the Fed regulate consumer credit again, as well as regulate residential mortgages.104 In response, the Fed set loan-to-value and maturity limits.105 When it did in 1949, consumer credit growth was limited.106 Similarly, when it did in 1951, housing production fell by one quarter,107 but when these restrictions were removed, “there were many signs of excess in housing construction” by 1955.108 By 1951, selective credit regulation had become a conventional and effective tool.
C. The Fed Accord (1951–1969)
While 1951 is seen as another transformative period for the Fed,109 it is also consistent with the Fed’s role as credit regulator. After WWII, the Fed opposed the policy of supporting Treasury rates, which prevented it from using open market operations to regulate the amount of credit in the economy. Specifically, by committing to buy Treasuries at a set price, the Fed was forced to add additional liquidity in the economy, risking inflation.110 The government had issued large amounts of debt during WWII and the start of the Korean War.111 Thus, anyone with Treasuries could sell them to the Fed for money, expanding the money supply and increasing the holder’s purchasing power, causing broad inflation.112 As a result, that year, Treasury and the Fed reached an “Accord” that the Fed would no longer have to peg Treasury rates.113
President Truman opposed the Accord, preferring to use selective credit regulations to stem inflation.114 He argued that “[c]hanging the interest rate [was] only one of several methods to . . . curb[] credit expansion.”115 In fact, he even considered using the TWEA or Emergency Banking Act of 1933116 to require banks to lend “only under regulations issued by the [Treasury] Secretary.”117 But since the source of inflation was broader — for example, businesses borrowed a lot but did not fall under any existing credit regulations — selective credit regulation was not enough to stop inflation from occuring.118
Today, some view the Accord as the Fed’s abandonment of selective credit regulation for more “orthodox” tools like interest rates.119 While the Accord allowed the Fed to use open-market operations again, it was not a rejection of selective credit regulation; indeed, the Fed was initially unsure how market operations would work.120 And until 1952, the Fed still had legal authorization to deploy selective credit regulations, publicly noting they were useful.121 In 1951, Chair William McChesney Martin, Jr., said the “objective” of selective credit regulation was the same as the “broader, traditional means of affecting the supply of credit, such as open market operations . . . and reserve requirements.”122 Later on, he claimed it was their “discontinu[ance]” that “increased the dependence on general credit measures for restraining excessive credit.”123
Likewise, in 1952, the Fed did not view its role as different than prior Feds. When describing this role, Martin wrote that “the long-run purpose . . . is to minimize economic fluctuations caused by irregularities in the flow of credit and money.”124 He noted this “purpose” was the same one that the Fed had had “throughout its history,” including in its 1923 annual report.125 And he stated it was consistent with the Employment Act of 1946,126 regarded as the predecessor to the Fed’s current mandate.127 The way Martin connected the Act to the Fed’s role is even similar to the wording in the current mandate: He elaborated that the language “creating and maintaining[,] in a manner calculated to foster and promote . . . the general welfare . . . to promote maximum employment, production, and purchasing power” implied “a directive [for the Fed] to determine policies with a view to longer-run economic stability.”128 But he noted: “Credit and monetary policy alone . . . cannot attain the indicated goal of steady economic progress.”129 This view was not unique to the Fed either; even economist Milton Friedman said that the “first and most important lesson . . . is that monetary policy can prevent money itself from being a major source of economic disturbance,”130 not that the Fed should fix all price-level changes.131
Congress ultimately repealed selective credit regulation,132 to the delight of manufacturing and retailers’ lobbyists.133 But the Fed found it to still be effective. In describing the “specific activities” the Fed had used to influence credit in the past, Martin cited “directly affecting the equity margin or maturity terms of selected types of loans extended by banks and other lenders.”134 Martin asked Congress to reinstate such powers as late as 1969.135 Several members of Congress also supported reviving Regulation W.136 So, while the Fed lost the tool of selective credit regulations, that did not reflect a change in the Fed’s underlying role or objective.
D. Standby Credit Controls (1969–1980)
After several years, Congress succeeded in passing the Credit Control Act of 1969137 (CCA), which created new credit regulation authority.138 The CCA gave the President broader authority than previous bills had: The CCA allowed the President to “authorize the [Fed] to regulate and control any or all extensions of credit,” not just consumer or real estate credit.139 To do so, the President had to find “that such action [was] necessary or appropriate for the purpose of preventing or controlling inflation generated by the extension of credit in an excessive volume.”140
This broader language was intentional. Congress wanted to give “the broadest possible spectrum of alternatives in fighting inflation, curbing unnecessary extensions of credit, and channeling credit into housing and other essential purposes.”141 Notably, the CCA called out “inflation generated by the extension of credit in an excessive volume,”142 a caveat that seems to imply that the CCA was not meant to address other sources of inflation. An underlying concern was that when the Fed uses “general interest rate increases to fight inflation[, it] is not neutral in its effects on the economy,” disproportionately falling on “small businessmen and on construction and other long-term investment,” but not “speculative excesses.”143 Congress also expressed a concern that general monetary policy could sometimes be inflationary.144
Several years later, Congress passed the Federal Reserve Reform Act of 1977145 (FRRA), “articulat[ing] a standard to guide monetary policy decisions by the [Fed].”146 While section 2A is now seen as a dual mandate to pursue stable prices and maximum employment,147 in 1975, Chair Burns thought the text was “add[ing] nothing new to the objectives of Federal Reserve policy as already defined” in the Employment Act of 1946.148 In an earlier draft of the FRRA, Congress had proposed that the Fed focus on the “long-run growth of the money supply.”149 However, Burns warned that the law should not “pay attention to one financial factor only, namely, the money supply.”150 He noted that “the willingness to use money, no matter how that elusive term is defined, depends heavily on the cost and availability of borrowed funds.”151 The final text of the FRRA said “monetary and credit aggregates” instead.152
Similarly, Burns argued that while the “[d]efeat of inflationary forces must . . . remain a major goal of public policy,”153 the Fed alone could not address inflation, and should instead push for other policies because inflation came from “interrelated, partly overlapping, waves of speculation” for mergers, the stock market, real estate, and industrial materials.154 When Congress passed the FRRA, the CCA was still law. In 1978, Congress passed the Humphrey-Hawkins Act,155 amending the FRRA. While some wanted this new law to modify the Fed’s mandate, Congress whittled its impact down to a “nullity.”156 Notably, the Humphrey-Hawkins Act did not amend the first sentence of the FRRA, still charging the Fed with “maintain[ing] long run growth of the monetary and credit aggregates.”157 If anything, it affirmed that monetary policy was not the government’s sole anti-inflation fighting tool, as it asked the President, not the Fed, to tackle inflation by addressing food and energy “bottlenecks.”158
II. The Shift from Credit to Inflation
Despite this lineage, the interpretation shown in Part I is no longer the orthodox one. Today, many view the Fed’s role as fighting inflation at large — specifically targeting a two percent annual rate — rather than addressing credit.159 The reason for this change is Paul Volcker, the Fed Chair from 1979 to 1987.160 The story goes that Volcker acted when no one else would, stopping high inflation in the 1970s by conducting tight monetary policy.161 If the Fed’s mandate is to stem inflation at any cost, then few can doubt that Volcker succeeded. But if the mandate is credit-based, then Volcker maybe acted when he should not have. This Part makes that case by reexamining Volcker’s actions during this period through the lens of a credit-based mandate.
First, Volcker believed that it was the Fed’s responsibility to address inflation, even though it was plausible that monetary or credit factors had not alone caused high inflation. While inflation was high across the 1970s, it accelerated by the end of the decade, exceeding ten percent in 1979.162 A large driver was the Iranian Revolution, which increased oil prices.163 From 1978 to 1981, imported crude oil and food prices rapidly grew.164 At the time, many blamed these “nonmonetary factors” for inflation, including Volcker’s predecessor, Chair Arthur Burns.165
Volcker saw the situation differently. He believed that high inflation was “ultimately related to excessive growth in money and credit,” a view he would express clearly only after he was confirmed as Fed chair.166 He thought that “[a]ttempts to pin all the blame for inflation on factors outside of our control would only doom our efforts to futility.”167 Thus, he saw his mission at the Fed as “slay[ing] the inflationary dragon.”168
One might counter that Volcker’s nomination as Fed chair was an implicit recognition by the President or Congress of this view and a signal that they wanted the Fed to act aggressively. It is true that high inflation had not only eroded people’s paychecks, but also their “confidence in the [Carter] administration’s ability to combat rising prices.”169 And President Carter wanted to stop it.170 But in July 1979, when he nominated Volcker, he did not necessarily want the Fed to act aggressively.171 In fact, “Carter did not know Volcker well,” choosing him “in haste.”172 Congress in the Humphrey-Hawkins Act had also set a three percent unemployment target.173 Testifying before Congress, Volcker also repeated the then-conventional view that inflation came, at least in part, from nonmonetary factors.174 Even if Volcker deeply believed that the Fed should act, such views were contrary to those of Congress and the President, both of whom did not anticipate very high interest rates.
Second, Volcker acted in a manner that did not target the economy’s long-run potential to increase production. Volcker wanted to “mak[e] a dramatic move that would be seen as a departure from past methods of operating.”175 In 1979, instead of targeting rates, he changed how the Fed conducted monetary policy by targeting bank reserves.176 By reducing the supply of bank reserves, borrowers would bid up the price of scarcer reserves.177 While interest rates rose to nearly twenty percent, inflation refused to fall.178 Since this inflation was not due to excessive money supply growth, Volcker’s plan was not necessarily going to work.
Meanwhile, these new policies came at a very high cost. High interest rates lowered aggregate demand and millions were forced into unemployment.179 By the end of 1982, the unemployment rate was 10.8%; in capital-expenditure-heavy sectors, like construction and automobiles, it reached as high as 22% and 24%, respectively.180 Notably, these sectors were also highly unionized,181 suggesting that labor-based causes of inflation could have potentially been addressed by noncredit means — an approach that Chair Burns had suggested.182 Volcker’s approach directly contradicted Congress’s 3% medium-term unemployment rate target, sacrificing millions of jobs to achieve lower inflation.183
Higher rates also killed capital-intensive projects and development, attracting capital into financial speculation.184 While Volcker argued such pain was necessary because the economy’s long-run potential could only be achieved with price stability,185 this outcome seems consistent with increasing production. In fact, a prior Congress had warned that higher rates could have an “inflationary” effect by discouraging housing construction that could have grown supply and lowered housing costs.186
In retrospect, it appears that Volcker and the other members of the Fed did not entirely know how the new policy would work. In July 1980, when a Fed governor asked how long the Fed would need to maintain a restrictive policy, another responded, “[w]e don’t know.”187 In July 1981, Volcker was not optimistic about the Fed’s efforts to tackle inflation.188 By July 1982, Volcker noted, “I don’t know whether anybody around here has any bright ideas.”189 Years later, Volcker admitted “that he had worn a path into his office carpet while waiting for inflation to surrender.”190 Ultimately, Volcker valued price stability over goals, like employment or investment, that may have been just as, if not more, critical to the economy’s long-run potential to increase production.191
Third, Volcker lowered a credit aggregate when he thought that doing so could hurt the economy’s long-run potential to increase production — the exact opposite of the Fed’s mandate.192 When the Fed first targeted bank reserves in 1979, it did not initially bear fruit; inflation remained high.193 In January 1980, Senator Ted Kennedy, running against Carter for President, argued that President Carter had not done enough and pushed for price and wage controls.194 In an election year, President Carter wanted to use credit regulation to fight inflation.195 But Volcker thought that it would be “counterproductive.”196 As he later recounted, “[e]xcessive credit wasn’t the problem.”197 To his credit, if inflation came from energy or food shocks, reducing credit would not necessarily fix energy or food supply.198 And data showed that consumer credit had slowed since October 1979.199
But the CCA only allowed the President to “authorize” the Fed to do credit regulation.200 The Fed still had to choose to implement it.201 The Fed also had discretion on how to operate it. Although Volcker thought that the CCA was entirely unnecessary, when President Carter asked him to deploy it, he acquiesced.202 On March 14, 1980, President Carter announced his authorization of credit controls.203 While President Carter noted that “[t]he traditional tools used by the Federal Reserve to control money and credit expansion are a basic part of the fight against inflation,” they were not the sole tools.204 Credit controls, he noted, were needed “so that effective constraint can be achieved in ways that spread the burden reasonably and fairly.”205 Volcker still thought that the Fed had no reason to reduce the consumer credit aggregate206 (even if President Carter did207). So if the Fed’s mandate is to “maintain . . . growth of the . . . credit aggregates commensurate with the economy’s long run potential to increase production”208 and Volcker did not think that President Carter’s plan would achieve this goal, Volcker was plausibly going against the Fed’s mandate.
Volcker’s solution, to satisfy President Carter while not hurting the economy, was to “ma[ke] the credit controls as ineffective as [he] could possibly make them.”209 As a result, it was unclear how the program would work.210 Banks could not lend six to nine percent more than they lent in 1979.211 But the Fed did not initially clarify how to calculate this growth.212 It required lenders to set aside fifteen cents of each dollar lent to consumers.213 But unlike prior consumer, housing, and stock credit regulations, all of which set limits based on characteristics of the borrower,214 these applied to lenders.215 So each lender had to identify who it could still lend to. It also “discouraged banks from . . . financing corporate takeovers or mergers, [or] lending for speculative purposes.”216 In total, these policies “bore little resemblance” to prior regulations.217
Despite Volcker’s intentions, the program’s impact was dramatic. As credit controls snapped into place, gross national product (GNP) plummeted: After April 1980, GNP fell at an 8.5% annualized rate by June, and unemployment grew from 6.2% to 7.8% by May.218 The response shocked the Fed.219 While the program “[was] largely symbolic and without teeth,” it nonetheless “induced consumers to alter their buying behavior”;220 out of “patriotic duty,” some consumers cut up credit cards and sent them to the White House.221 Lenders hesitated to lend as they tried to understand applicable rules.222 At the same time, Volcker’s bank-reserve policy began to slow the economy.223 As both demand and supply fell, the Fed realized its controls had unexpectedly contributed to a massive recession.224
The consequence was that credit regulation became discredited. In July 1980, the Fed removed credit controls; President Carter revoked the authorization for the Fed to use the CCA shortly thereafter.225 Once the credit controls were lifted, “private sector demand ‘rebounded with surprising alacrity.’”226 Congress immediately proposed to sunset the CCA in 1982.227 While President Carter opposed removing a tool from the inflation-response arsenal,228 he was outnumbered. While he hoped a future Congress would authorize it one day,229 the body never did.
Meanwhile, Congress was evidently furious with Volcker. But judicial paths were lacking. Several attempts to sue the Fed had failed over justiciability and standing issues.230 Congress considered legislation to order the Fed to lower rates, and by 1982, it almost did so.231 But before they did, in 1982, inflation finally fell.232 Whether the Fed was responsible, lucky, or a mix or both, history is written by the victors.233 Now, Volcker is credited with “slay[ing] the inflationary dragon.”234 For the next forty years, inflation remained relatively low.235 In contrast, due to the poor implementation of credit regulation by President Carter (using it for the wrong reasons) and by Volcker (misapplying it),236 credit “controls,” despite their long lineage, have become anathema to many policymakers.237
Professor Skinner argues that monetary policy is “‘activist’ when it breaks from statutory text, purpose, or historical usage of a power.”238 Despite the positive substantive outcome, it appears that the Fed acted contrary to its statutory mandate by targeting noncredit-based inflation, seeking outcomes that were contrary to the economy’s long-run potential, and reducing credit aggregates that hurt the economy (especially when combined with Volcker’s new monetary policy approach).239
Is this result good or bad? On one hand, other political branches had failed to solve inflation. Volcker’s ex post valorization reflects some level of approval for his policy actions. But what if he had failed? Should future Fed Chairs act contrary to the Fed’s mandate on the belief that they, and they alone, can solve a crisis? While it is beyond the scope of this Note to provide an adequate answer, this question strikes at the heart of several contemporary debates around administrative power.
III. Reconsidering the Mandate
Today, the Fed is expected to control aggregate inflation.240 One reaction is that the modern interpretation, even if wrong, has been harmless (or even positive). But to make that determination, it is worth considering how the Fed would act differently under a credit mandate. First, it would address excessive credit, even if general inflation is not an issue. Second, it would not raise rates to stop general inflation when credit is not responsible. This Part offers two examples where the Fed could have acted differently to illustrate these differences.
A. Junk Bonds (1985)
If the Fed viewed its mandate as credit, it may have acted more aggressively to stem large junk bond issuances that led to financial instability. In 1985, after allegedly winning the war against inflation, Volcker turned his attention to a new threat: leveraged buyouts.241 In the 1980s, U.S. firms witnessed a wave of hostile takeovers by corporate “raiders” like Carl Icahn and T. Boone Pickens.242 Critically, these acquisitions used risky, high-yield debt (“junk bonds”) for funding.243 During the 1980s, junk bonds markets grew from obscurity to nearly $200 billion.244 Volcker was deeply concerned about such excessive debt.245
In response, Volcker considered using margin requirements to limit how much debt businesses could borrow,246 a response in line with a credit mandate. In fact, the Fed’s general counsel advised the Fed that it “could interpret the rule broadly.”247 This interpretation was not radical: In a previous lawsuit about a hostile takeover, one district court surmised that an acquirer had “taken advantage of a possible oversight on the part of the Board in formulating the public offering exception to the margin regulations.”248 Section 7(b) of the Securities Exchange Act of 1934 also states that the Fed can prescribe requirements “as it deems necessary or appropriate for the accommodation of commerce and industry, having due regard to the general credit situation.”249 This language resembles the Fed’s open-market operation statutes.250
When Volcker’s plan leaked, several agencies opposed it.251 Assistant Attorney General Douglas Ginsburg argued it would distort markets.252 An investment bank considered suing the Fed for ultra vires action,253 despite Congress’s creation of margin requirements due to Fed inaction when faced with a prior speculative credit boom.254 The Fed backed down, issuing a “symbolic” rule255 and asking Congress to act.256
The combination of Volcker’s rate hikes in the 1980s and his inaction in not stemming junk bonds in 1985 likely contributed to several prominent savings and loan institutions’ (S&L) downfalls. Historically, S&Ls had provided low-interest, long-term home mortgages, but higher rates from Volcker’s policies raised the rates that S&Ls had to pay depositors, causing S&Ls to pay depositors more than they earned on their mortgages.257 In response, Congress deregulated S&Ls, letting them buy other securities to cover these higher costs.258 Several large S&Ls heavily invested in junk bonds.259 When the price of junk bonds fell in 1989, such S&Ls went bankrupt.260 While this event did not lead to a broader financial crisis, it threatened one, and it required the government to bail out S&Ls’ depositors.261 Under a credit mandate, the Fed could have reduced junk bond issuance ex ante to mitigate this outcome.
B. COVID-19 (2021–2022)
But what should the Fed do when price levels rise? A credit-based interpretation of the mandate would not imply that the Fed never has a role. Instead, as Professor Lev Menand notes, it implies that the Fed should act “only when the rate of expansion of money and credit is inconsistent with full capacity utilization in the long run.”262 In 2021–2022, as mentioned, inflation grew.263 But some economists have argued that inflation came from supply-side factors, not money and credit.264
When the Fed first raised rates, Chairman Jerome Powell recognized that “part of inflation coming down . . . is clearly to do with factors other than our policy,” citing supply chains.265 He emphasized targeting long-run inflation.266 But many criticized the Fed for inaction.267 As inflation persisted, the Fed adopted stronger rhetoric: “It is the Fed’s job to bring inflation down to our 2 percent goal, and we will do so.”268 While inflation has declined since, it is unclear whether the Fed was responsible. When the Fed raised rates, it operated on a theory that 1.2 million people would become unemployed, which would lower aggregate demand.269 That prediction did not occur, however: While inflation fell from 9% in June 2022 to 2.5% in November 2024, unemployment rose “modestly” from 3.6% to 4.1%, respectively.270 Maybe higher interest rates lowered inflation through some unknown transmission mechanism. But perhaps the Fed’s actions were not so impactful.271 As former Fed Governor Daniel Tarullo warned in 2017, an executable model of how the Fed can accurately act to control inflation does not exist.272
In other words, under a credit mandate, the Fed should be more cautious of overreliance on headline numbers or rule-based methods, which tie the Fed to variables that it does not fully control (or frankly understand). Error costs are not small: The Fed was willing to risk losing millions of jobs to fight inflation.273 Even if higher interest rates definitively can reduce inflation through more unemployment, just because one can make a house warmer by blasting the oven at higher heat does not mean that one should do so (especially if a more tailored solution, like a thermostat, may work). Worse, a formulaic stance ignores the risk that rate hikes can exacerbate inflation when credit is not the cause. For example, high rates can cause housing prices to rise since it becomes harder to build new supply, deterring those with low-rate mortgages from selling existing houses.274 Reality is more complicated.
The Fed’s current monetary policy also has distributive impacts: The Fed pays banks to hold reserves.275 Because banks hold over $3 trillion of reserves and the interest rate paid on reserves is over five percent,276 the Fed likely paid banks over $150 billion in 2024. While banks may have shared some of the revenue from higher rates with their depositors, since banks did not raise deposit rates by nearly as much, banks made a large profit from this monetary policy.277
A credit-based interpretation of the Fed’s mandate would try to find the specific causal mechanisms between the Fed’s policy and its intended outcome (in this case, price-level changes). By laying out a more granular theory, the Fed can be better prepared to test how its tools propagate into the broader economy. In doing so, Congress can understand where it should play a role as well. If inflation is fueled by credit, the Fed should raise rates (or be empowered by Congress to directly deter specific uses of credit via credit controls278). But if the Fed is not responsible, Congress or the President should consider using other tools, like stopping monopolistic behavior, deploying strategic commodity reserves, or even implementing wage and price controls, that may be better suited to the particular noncredit price-level issues at hand. But iterating policy in such fashion will never occur if we simply assume that the Fed should always respond whenever a broad output (the price level) happens to rise with a blunt tool (interest rates).
Conclusion
This Note argues the Fed’s credit mandate has been forgotten. As a matter of text, the Act says credit aggregates, not a two percent inflation target. As a matter of purpose, Congress empowered the Fed with tools affecting the level of credit, not all price changes. As a matter of history, the Fed repeatedly saw its role as regulating credit, not as the sole economy-wide price-level overseer. Understanding the Fed’s mandate is even more relevant given growing scrutiny over other administrative agencies’ statutory mandates. Even if the Fed merits special treatment due to the “unique function” of monetary policy,279 where should we draw the line? Can the Fed interpret its ambit so broadly as to tackle climate change, inequality, trade imbalances, or any issue affecting prices?280 This is not a theoretical question. As new crises and issues challenge the Fed, it is being asked to take on more responsibility.281 Without defining the logic and limits of the Fed,282 as Milton Friedman presciently warned, “we are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve, and, as a result, in danger of preventing it from making the contribution that it is capable of making.”283