Fed chief Bernanke urges better financial regulation to prevent crises
Monday, January 4, 2010
Better regulation is the key to avoiding future financial excesses, Federal Reserve Chairman Ben S. Bernanke said Sunday, arguing that the Fed's low-interest-rate policies early in the decade were not a major cause of the housing bubble.
Bernanke did suggest, however, that he is open to using monetary policy -- the power to expand or contract the money supply by adjusting interest rates -- to combat future bubbles, but would do so only if regulatory policy did not contain financial risks. His comments, before the American Economic Association, reflect efforts by economists at the Fed and beyond to assess the lessons from the financial crisis and recession of the past two years.
"Having experienced the danger that asset bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated," Bernanke said in Atlanta, according to a published text.
He added that if the regulatory system isn't reformed to deal with future bubbles or if it cannot keep risks in check, "we must remain open to using monetary policy as a supplementary tool for addressing those risks -- proceeding cautiously and always keeping in mind the inherent difficulties of that approach."
The difficulties he has in mind: It can be hard to know for sure when a bubble is underway -- many economists argued that high home prices earlier in this decade were justified, for example. Also, interest rate increases to combat bubbles are a blunt instrument and can drag down the entire economy.
Bernanke, as a Fed governor, was an advocate of the decision to cut the Fed's target interest rate to 1 percent in 2003, leave it there for a year and raise it only slowly thereafter
Some economists -- and lawmakers -- have assailed the Fed for keeping rates low through that period. They say low rates resulted in cash gushing through the economy, some of which went to bidding up the prices of houses and other assets beyond levels justified by their fundamentals.
"While keeping interest rates low for a protracted period of time, the Fed seemed remarkably unconcerned about the possibility of igniting a different financial crisis by inflating a housing price bubble," said Sen. Richard C. Shelby (R-Ala.) in a Senate Banking Committee session last month.
That was one reason, he said, he voted against moving Bernanke's nomination for a second term to the full Senate.
On Sunday, speaking at the annual meeting of the major association for academic economists, Bernanke laid out a case that the interest rate policy was, at best, a modest contributor to the over-inflation of home prices.
For one thing, there were home-price bubbles in many countries around the world -- even many that were not as loose with their monetary policy. Such countries as Britain, New Zealand and Sweden had tighter monetary policy, yet their home prices rose more, and monetary policy explained only 5 percent of the variation in home prices.
By contrast, Bernanke showed analysis suggesting that capital inflows, such as those the United States received from China and other Asian nations, explained 31 percent of the variation in home prices, supporting a theory he has long voiced: that global financial imbalances drove the crisis.