WASHINGTON--Federal Reserve Governor Jeremy Stein on Friday said the central bank should raise interest rates when needed to prevent financial excesses from building in markets and argued the bond market may provide guidance to policy makers on when financial vulnerabilities exist.
Specifically, Mr. Stein argued that the Fed needed to look carefully at interest-rate markets for signs of excess that could signal future instability.
For instance, when long-term interest rates were unusually low compared to the outlook for short-term interest rates, or when investors demanded small premiums on risky debt such as corporate bonds or mortgage bonds relative to low-risk debt like Treasurys, instability in credit markets might be brewing which could later damage the broader economy, he said.
He said the Fed may want to push against these developments when needed with tighter credit policies to prevent more economic trouble down the road, even if unemployment is at an elevated level that would, all else being equal, dictate looser policy.
"Monetary policy should be less accommodative...when estimates of risk premiums in the bond market are abnormally low," he argued in remarks prepared for delivery at a conference hosted by the Federal Reserve, the European Central Bank and two academic institutions.
He stressed, however, that his idea was one for policy makers and economists to explore further and see if it could be useful in helping figure out how to adjust monetary policy to accommodate concerns about financial stability.
Mr. Stein said he didn't intend his proposal "as a comment on the current stance of our policy." Mr. Stein raised some of his concerns about the financial-stability implications of the Fed's easy-money policy in a widely discussed speech last February, during which he first publicly voiced his belief that the Fed should be considering responding to such threats by raising rates.
His remarks Friday showed him building on some of that work. In his speech Friday, Mr. Stein noted that, hypothetically, if his approach had been in practice during the spring of 2013, when term premiums were very negative, it would have called for the Fed to pull back on its monthly pace of bond purchases.
"The informal intuition I have in mind is that there is a cost associated with pushing risk premiums too low, because doing so increases the likelihood that they may revert back in a way that hinders the Federal Reserve's ability to achieve its mandated objectives," Mr. Stein said.
He pointed to data and research that suggest that changes in risk premiums in bond markets are associated with declines in economic activity and employment down the line.
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Specifically, Mr. Stein argued that the Fed needed to look carefully at interest-rate markets for signs of excess that could signal future instability.
For instance, when long-term interest rates were unusually low compared to the outlook for short-term interest rates, or when investors demanded small premiums on risky debt such as corporate bonds or mortgage bonds relative to low-risk debt like Treasurys, instability in credit markets might be brewing which could later damage the broader economy, he said.
He said the Fed may want to push against these developments when needed with tighter credit policies to prevent more economic trouble down the road, even if unemployment is at an elevated level that would, all else being equal, dictate looser policy.
"Monetary policy should be less accommodative...when estimates of risk premiums in the bond market are abnormally low," he argued in remarks prepared for delivery at a conference hosted by the Federal Reserve, the European Central Bank and two academic institutions.
He stressed, however, that his idea was one for policy makers and economists to explore further and see if it could be useful in helping figure out how to adjust monetary policy to accommodate concerns about financial stability.
Mr. Stein said he didn't intend his proposal "as a comment on the current stance of our policy." Mr. Stein raised some of his concerns about the financial-stability implications of the Fed's easy-money policy in a widely discussed speech last February, during which he first publicly voiced his belief that the Fed should be considering responding to such threats by raising rates.
His remarks Friday showed him building on some of that work. In his speech Friday, Mr. Stein noted that, hypothetically, if his approach had been in practice during the spring of 2013, when term premiums were very negative, it would have called for the Fed to pull back on its monthly pace of bond purchases.
"The informal intuition I have in mind is that there is a cost associated with pushing risk premiums too low, because doing so increases the likelihood that they may revert back in a way that hinders the Federal Reserve's ability to achieve its mandated objectives," Mr. Stein said.
He pointed to data and research that suggest that changes in risk premiums in bond markets are associated with declines in economic activity and employment down the line.
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