Fed's George: Wrong to Rely on Regulation Alone to Thwart Bubbles

        By Michael S. Derby
        NEW YORK-- Federal Reserve Bank of Kansas City President Esther George said it is a mistake for policymakers to rely on regulatory powers alone to deal with financial market imbalances.
        In a speech delivered on Tuesday in Manila, the central banker argued that modest rate rises early in a business cycle can help restrain the sort of forces that can later metastasize into damaging financial bubbles.
        "Interest rate policy used earlier in the cycle can foster a more stable financial landscape as a business cycle matures," Ms. George said in the text of her remarks before a gathering of the Financial Stability Institute and Bank for International Settlements.
        Ms. George did not comment directly on the U.S. policy and economic outlook. She is not currently a voting member of the monetary-policy setting Federal Open Market Committee. Ms. George has long been uneasy with the ultra-easy stance of near-zero interest rates currently maintained by the Fed. She is one of a small group of Fed officials who have worried Fed policy is creating too much risk in financial markets.
        Very easy Fed policy is designed to drive investors into riskier assets because that type of buying is more likely to create stronger levels of growth. But with stock indexes moving sharply higher, amid rock bottom borrowing costs and signs of excess in some sectors, some worry Fed policy is distorting markets.
        Many Fed officials counter that it is better to deal with financial imbalance by way of regulatory and supervisory actions. They believe using interest-rate policy is too blunt a tool, because rate rises aimed at quelling excess markets can create significant headwinds to growth and hiring.
        Ms. George said both sides of the policy making ledger must work together, to the extent they can. "Policymakers should reassess the assumption that monetary policy and macroprudential regimes can be used independently," she said.
        "Modestly tighter policy earlier in the business cycle expansion could moderate risk-taking and the potential for destabilizing financial imbalances to build," Ms. George said. Getting ahead of markets is important: "Once asset values or credit growth has risen to a level warranting concern, it is likely too late for monetary policy to smoothly unwind these imbalances without triggering a sharp reversal that ultimately inflicts damage on the real economy," she added.
        "Using monetary policy to prick bubbles after they have developed, to slow elevated levels of credit growth, or to encourage firms to scale back on high levels of leverage are likely to end poorly," the official said.
        Meanwhile, Ms. George said the regulatory side is still untested. "I often hear the view that macroprudential policy should be the 'first line of defense' for maintaining financial stability. Unfortunately, this approach expects too much of tools for which our understanding is imperfect."
        Few other Fed officials have expressed such doubt about the power of regulatory tools to deal with bubbles. One who has shared that view is St. Louis Fed President James Bullard . He said, last week, "it's naive to think that macro prudential tools as they exist today are sufficient" to tackle new bubbles without deploying the Fed's interest rate tools at the same time.
        Ms. George also said in her speech that regulators should not ignore more focused, institution-by-institution oversight. She added that bank stress tests can't fully gauge the real level of risk in the financial system.
        (END) Dow Jones Newswires

        February 09, 2015 20:45 ET (01:45 GMT)

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