–Fed Needs To Think About How Low Rates Affect Financial Risks
By Steven K. Beckner
(MaceNews) – Although the U.S. economy has been recovering “faster than anticipated,” the Federal Reserve still needs the assistance of fiscal policy in returning to full employment and a more acceptable inflation pace, Cleveland Federal Reserve Bank President Loretta Mester said Monday.
Mester said the Fed is not out of monetary policy ammunition, although she was not specific about what more the central bank could do.
Mester, speaking to reporters following an address to the Philadelphia Fed’s annual Fintech Conference, also returned to a recent theme of hers – the need for the Fed to look more carefully at the costs, as well as the benefits, of its low interest rate policies and at how it can best marry monetary and supervisory policies to guard against financial instability.
Mester, a voting member of the Fed’s policymaking Federal Open Market Committee, joined her colleagues last Thursday in reaffirming its intention to keep buying $120 billion of bonds per month and to hold the federal funds rate in a zero to 25 basis point range for the foreseeable future until it achieves its maximum employment and price stability objectives. The latter includes an expressed desire to “achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time.”
Before the coronavirus pandemic triggered government-ordered lockdowns that tipped the economy into recession, Mester was often thought of a being on the “hawkish” side, but she indicated she remains fully on board with the Fed’s ultra-easy monetary stance for now.
“I’m very comfortable where we are now,” she said, adding, “There is more we can do in terms of the asset purchase program.”
She said bond purchases “can be adjusted” in various ways, and noted that Fed Chairman Jerome Powell is in the process of consulting with the Treasury Department on extending the Fed’s panoply of special lending and credit facilities under its Section 13-3 authority.
Mester said if it was up to her all of those facilities would be extended.
The Fed’s low rate settings, asset purchases and lending programs are working in tandem to “support the recovery and get back to full employment and price stability.”
“I don’t think we’re out of ammunition,” she added. The Fed’s policies “have been efffective so far and will continue to be effective.”
Echoing Powell and others, Mester said “further fiscal support would be very welcome.”
While monetary policy is the best tool “to support the recovery overall,” fiscal policy can provide “targeted” relief.
Monetary and fiscal policy need to keep working together, she said, because although the economy has “come back more solid than I anticipated,” there is “still a long way to go.”
She noted that the economy has regained only half of the jobs lost since the pandemic began and that “inflation is running well below our goal.” What’s more, she said growth seems to be slowing, even though “we still haven’t gotten to a sustained, broad-based recovery.”
So she said it’s important that the Fed continue to pursue low rates at both ends of the yield curve. She said holding the 10-year Treasury note yield below 100 basis points has been particularly helpful to housing and other “interest sensitive sectors.”
At the same time, Mester has been one of the few Fed officials to publicly express concern about potential untoward financial market effects of low rates, cautioning on Oct. 21 that “in an environment with low neutral rates, a persistently accommodative monetary policy could, in some cases, increase the vulnerabilities of the financial system by encouraging higher levels of borrowing and financial leverage, increased valuation pressures, and search-for-yield behavior.”
Mester was reminded by this reporter of those comments on a day when stock prices leaped to near record levels and when the Fed’s Financial Stability Report called asset valuations “elevated” and warned they are “vulnerable to significant declines should investor risk sentiment fall or the economic recovery weaken.”
She responded by saying the Fed needs to rethink its ways of handling financial issues.
“I think it’s important that we examine, just as we did the monetary policy framework what the implications are [of a low interest rate environment] for financial stability, of regulatory policy – microprudential and macroprudential – and then the interrelationship between monetary policy and financial stability.”
“Your microprudential, your macroprudential and your monetary policy are not independent,” she continued. “They’re all working together.”
Mester reiterated that persistently low rates lead to “search for yield behavior,” and said the Fed should be “assessing what the costs and benefits are of a low interest rate environment.”
“You need to put the potential for search-for-yield on the cost side,” she went on. “On the benefit side, though, at times you need to have that support in the economy or else things would be much worse in terms of the macroeconomy. And I think it’s worth thinking about how to incorporate those ideas into your setting of monetary policy.”
“You know, we always say, and I believe this, that we want to rely on microprudential and macroprudential policy to make sure the financial system stays stable and monetary policy for macro(economic) stability,” she said.
“I believe that, and it’s part and parcel of how the economy has been doing its policy, and I think that’s right,” she added, “but I also think it’s important that you think through so you know what those interrelationships are and understand that when you’re in a low interest rate environment, the monitoring that you need to do might be different than it was before.”
Mester said “this is not a current worry of mine, but it is something that I think should be on our agenda as we go forward in thinking about how to do policy in a low interest rate environment, just as we did with the monetary policy framework.”
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Contact this reporter: steve@macenews.com.
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