The Federal Reserve doesn’t need to expand its focus from its dual mandate to take financial-stability concerns into account, Fed governor Jeremy Stein said Sunday.
Mr. Stein, who has expressed worries that the Fed’s easy-money policies could spark instability across the financial system, said his “first instinct” would be not to add financial stability as some sort of separate task for the central bank to carry out.
Approaching financial stability through the lens of the Fed’s dual mandate to achieve maximum employment and price stability “will give you a little bit of analytical discipline,” he said during a panel discussion at the International Monetary Fund’s spring meetings.
In other words, Fed officials should only take action on financial-stability concerns when there is evidence that the activity in question is threatening to spur higher unemployment or push inflation significantly above or below the central bank’s 2% target.
During the panel, Mr. Stein reprised a proposal he first unveiled in a speech last month: The Fed should look to the bond market for guidance on when financial excesses are building, and the central bank should raise interest rates to tamp down emerging threats.
Specifically, Mr. Stein argues that interest-rate markets can reveal to the Fed signs of excess that could signal future instability.
Trouble may be brewing when long-term interest rates are unusually low compared to the outlook for short-term interest rates, or when investors demand small premiums on risky debt such as corporate bonds or mortgage bonds relative to low-risk debt like Treasurys, he said.
Mr. Stein, who is set to depart the Fed on May 28, argued during the discussion Sunday that his proposal is really just a shift in emphasis in what the Fed is already doing.
Fed officials take asset prices and risk premiums into account implicitly when making policy decisions because these factors have implications for the economic outlook, he said. If investors are demanding greater returns for risky debt, the economic outlook has deteriorated, he said.
He pointed to the Fed’s decision not to start winding down its then-$85 billion-per-month bond-buying program in September. Term premiums had risen a lot since June, and part of the decision not to start scaling back the bond-buying program at the September meeting “was likely informed by movement in asset prices,” he said.
Mr. Stein said his proposal would “put a little bit extra weight” on these interest-rate market indicators. For example, he said, if credit spreads widen officials should ease policy for two reasons: First is “the usual reason, which is the outlook has weakened.”
The second is that investors demanding bigger risk premiums is a sign “the financial system is probably a little safer, all else equal.”
wsj.com
Mr. Stein, who has expressed worries that the Fed’s easy-money policies could spark instability across the financial system, said his “first instinct” would be not to add financial stability as some sort of separate task for the central bank to carry out.
Approaching financial stability through the lens of the Fed’s dual mandate to achieve maximum employment and price stability “will give you a little bit of analytical discipline,” he said during a panel discussion at the International Monetary Fund’s spring meetings.
In other words, Fed officials should only take action on financial-stability concerns when there is evidence that the activity in question is threatening to spur higher unemployment or push inflation significantly above or below the central bank’s 2% target.
During the panel, Mr. Stein reprised a proposal he first unveiled in a speech last month: The Fed should look to the bond market for guidance on when financial excesses are building, and the central bank should raise interest rates to tamp down emerging threats.
Specifically, Mr. Stein argues that interest-rate markets can reveal to the Fed signs of excess that could signal future instability.
Trouble may be brewing when long-term interest rates are unusually low compared to the outlook for short-term interest rates, or when investors demand small premiums on risky debt such as corporate bonds or mortgage bonds relative to low-risk debt like Treasurys, he said.
Mr. Stein, who is set to depart the Fed on May 28, argued during the discussion Sunday that his proposal is really just a shift in emphasis in what the Fed is already doing.
Fed officials take asset prices and risk premiums into account implicitly when making policy decisions because these factors have implications for the economic outlook, he said. If investors are demanding greater returns for risky debt, the economic outlook has deteriorated, he said.
He pointed to the Fed’s decision not to start winding down its then-$85 billion-per-month bond-buying program in September. Term premiums had risen a lot since June, and part of the decision not to start scaling back the bond-buying program at the September meeting “was likely informed by movement in asset prices,” he said.
Mr. Stein said his proposal would “put a little bit extra weight” on these interest-rate market indicators. For example, he said, if credit spreads widen officials should ease policy for two reasons: First is “the usual reason, which is the outlook has weakened.”
The second is that investors demanding bigger risk premiums is a sign “the financial system is probably a little safer, all else equal.”
wsj.com
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