The Fed’s Financial Stability Paradox: The Political Economy of Central Bank Mandates in the United States

Abstract Following the 2008 financial crisis, the Federal Reserve restored its historic financial stability mandate with new monetary tools to help mitigate the credit crunch and stimulate the economy. This article develops a new theory about how political constraints facing monetary institutions limit the effectiveness of these tools. It develops the concept of the Fed’s financial stability paradox , suggesting that the central bank’s implicit financial stability goals can complicate its ability to meet its dual mandate of full employment and price stability. In a highly financialized world, the Fed often provides easy credit with exceptional monetary instruments, such as quantitative easing, to contain financial instability. Without sufficient regulatory tools, however, these monetary actions risk stoking moral hazard and fueling financial fragility. To test these theoretical priors, this article conducts a plausibility probe of the 2023 regional banking crises, finding that political constraints reduced the feasibility of more traditional banking supervisory powers, placing the financial stability onus disproportionately on the Fed’s quantitative easing.