Federal Reserve Vice Chairman Stanley Fischer on Thursday suggested that banking regulators should seriously consider broadening their goals to include financial stability as policymakers around the world debate strategies for preventing another global crisis.
Fischer argued that an explicit stability mandate could give regulators more firepower to combat risks as they emerge. The issue of how central bankers should address nascent bubbles has become a flash point in economics, with some worrying that years of ultralow interest rates and easy monetary policy could be fueling hidden excesses.
In a speech in Cambridge for the National Bureau of Economic Research — his first as vice chairman — Fischer warned that the U.S. structure for overseeing the financial system may not be up to its task.
“It may well be that adding a financial stability mandate to the overall mandates of all financial regulatory bodies … would contribute to increasing financial and economic stability,” he said, according to prepared remarks.
Fischer did not weigh in on whether central banks should use monetary policy — namely, interest rates — to combat bubbles. But he did point out that policymakers do not have a strong understanding of how well their regulatory tool kit might work.
As head of the Bank of Israel during the global crisis, for example, he employed several measures to rein in ballooning housing prices. These “macroprudential tools” included increasing bank capital requirements, restrictions on the terms of the mortgages they offered and limits on loan-to-value and payment-to-income ratios.
Fischer said forecasts of the impact of these changes typically overstated their effectiveness. Forcing lenders to link the bulk of a loan to a higher interest rate was the most successful measure, he said. Changing loan-to-value and payment-to-income ratios was moderately useful, while raising capital charges had little impact.
“We have relatively little experience of the use of such measures in recent years,” he said. “Policymakers may thus be especially cautious in the use of measures of this type.”
Fischer also noted that using those tools can also be politically sensitive and implementation can often require significant coordination among several regulatory agencies. He cited a recent speech by former Fed vice chairman Don Kohn, now a senior fellow at the Brookings Institution, that raised concerns about the lack of power vested in the U.S. Financial Stability Oversight Council to enact change.
Harvard economist Jeremy Stein, who sat on the Fed’s board of governors until earlier this year, has also pointed to the limited experience policymakers have with macroprudential regulation. Stein has been an influential voice arguing that central bankers should be open to using interest rates to combat financial excesses. In an interview with The Washington Post, he said there are economic costs to using both monetary policy and regulatory tools.
“The idea that there’s some purity — there’s one thing that’s purely macro, which is monetary policy, and one thing that’s purely regulatory — that’s a convenient benchmark,” he said. “I don’t think that’s entirely realistic.”
But Federal Reserve Chair Janet Yellen recently expressed confidence that regulatory changes could shore up the financial system, making it better able to withstand the inevitable bubbles when they arise. She said that she would be extremely wary of invoking interest rates in the name of financial stability, though she acknowledged there might be extreme circumstances in which it is warranted.
“Increased focus on financial stability risks is appropriate in monetary policy discussions, but the potential cost, in terms of diminished macroeconomic performance, is likely to be too great to give financial stability risks a central role in monetary policy decisions, at least most of the time,” she said during a speech at the International Monetary Fund in Washington last week.
Fischer also expressed skepticism on Thursday over proposals by some lawmakers to break up the country’s largest banks or limit their size. He suggested that it was unclear whether large institutions have lower financing costs because of an implicit government backstop or because they enjoy an economy of scale.
“Actively breaking up the largest banks would be a very complex task with uncertain payoff,” he said.