Prick asset bubbles with rates? Fed officials split

Fri Oct 2, 2015 4:23pm EDT
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By Jonathan Spicer

BOSTON (Reuters) - The question of whether the Federal Reserve should adjust interest rates to deflate risky financial market bubbles split some of its top policymakers on Friday, suggesting the controversial idea is re-emerging as the U.S. central bank approaches an historic policy tightening.

Giving the central bank an effective third mandate - beyond its formal objectives for inflation and employment - has won more adherents since the 2007-2009 financial crisis, which some blame in part on too-easy monetary policy in the preceding years that allowed risks to take root.

As the Fed approaches its first rate hike in nearly a decade, which could come this year, one reason to act sooner than later is to head off any brewing instabilities in risky corners of financial markets like leveraged loans, high-yield debt and even automobile lending.

So far the Fed's approach has been to use targeted financial regulations and supervision of banks and other firms - so-called macroprudential tools - to head off any emerging risks that could harm the broader economy. Monetary policy has been reserved for achieving the goals of 2-percent inflation and maximum stable employment.

But Fed officials discuss financial stability quite frequently in their meetings and those discussions already do influence policy decisions, according to a paper co-authored by Boston Fed President Eric Rosengren.

"There are reasons to believe that financial stability should be an explicit consideration of monetary policymakers," concluded the paper, published Friday at a Boston Fed conference on financial stability that was attended by central bankers from around the world.

Rosengren, among the dovish Fed officials who prefers to keep rates low to boost employment, called the research "an initial foray into this area ... but it does capture I think the way we seem to behave."

He urged his colleagues to think outside the inflation-and-employment box, noting that problems like income inequality, political gridlock, and years of rock-bottom rates globally seem "much more intractable now."   Continued...

A Federal Reserve police officer keeps watch while posted outside the Federal Reserve headquarters in Washington September 16, 2015.  REUTERS/Kevin Lamarque