The Federal Reserve announced Thursday that Jeremy Stein is stepping down from the board of governors to return to teaching at Harvard University.
Stein made his name as a sharp and influential voice within the central bank, particularly on financial arcana, since he was appointed two years ago. Though he has supported the Fed’s easy-money policies, he also proved willing to challenge the consensus view on the costs of the programs and the best way to wind them down.
Stein took office in May 2012, and his resignation will be effective at the end of next month. He has given 15 speeches during his term. Here are some of his greatest hits.
"Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter"
Feb. 7, 2013, at the Federal Reserve Bank of St. Louis
Stein made a cogent case for the possibility that the Fed’s efforts to stimulate the economy – namely, massive bond purchases and zero percent interest rates – could be stoking bubbles in some sectors of the credit market. Low returns on safe assets were creating incentives for investors to “reach for yield” through increasingly risky products. He also broached the idea that the Fed could use monetary policy to discourage such behavior, a highly controversial proposal that continues to dominate debate within the central bank.
I can imagine situations where it might make sense to enlist monetary policy tools in the pursuit of financial stability. Let me offer three observations in support of this perspective. First, despite much recent progress, supervisory and regulatory tools remain imperfect in their ability to promptly address many sorts of financial stability concerns. If the underlying economic environment creates a strong incentive for financial institutions to, say, take on more credit risk in a reach for yield, it is unlikely that regulatory tools can completely contain this behavior. This, of course, is not to say that we should not try to do our best with these tools -- we absolutely should. But we should also be realistic about their limitations.
"Banking, Liquidity and Monetary Policy"
Sept. 26, 2013, at the Center for Financial Studies in Frankfurt, Germany
Here he introduced the “Stein Rule” (our name, not his) for ending the Fed’s bond-buying program. Many investors were surprised when the central bank decided not to begin drawing down its purchases of long-term bonds in September. In fact, Stein himself suggested earlier in the year that he was in favor of starting in September.
But when that didn’t happen, he came up with another plan: Reduce the purchases by a set amount for each 10-basis-point decline in the unemployment rate. Though plenty of regional Fed presidents had weighed in on how the central bank should handle the process, Stein was the only member of the typically unified board of governors to submit such a public proposal. The central bank began scaling back its asset purchases in December at a steady rate of $10 billion a month, but it has not adopted any single metric for the cuts.
But I do think that, at this stage of the asset purchase program, there would be a great deal of merit in trying to find a way to make the link to observable data as mechanical as possible. For this reason, my personal preference would be to make future step-downs a completely deterministic function of a labor market indicator, such as the unemployment rate or cumulative payroll growth over some period. For example, one could cut monthly purchases by a set amount for each further 10 basis point decline in the unemployment rate. Obviously the unemployment rate is not a perfect summary statistic for our labor market objectives, but I believe that this approach would help to reduce uncertainty about our reaction function and the attendant market volatility. Moreover, we would still retain the flexibility to respond to other contingencies (such as declines in labor force participation) via our other more conventional policy tool -- namely, the path of short-term rates.
"Incorporating Financial Stability Considerations Into a Monetary Policy Framework"
March 21 at the International Research Forum on Monetary Policy
Stein built on his thesis that the Fed should be willing to raise short-term interest rates to counteract financial excesses. In this speech, he argued that the Fed should consider letting off the gas when the difference between short- and long-term interest rates are abnormally low. That approach would have called for the central bank to question continuing its bond-buying program last summer, when the rates were particularly depressed.
In addition, minutes of the central bank’s meeting in January showed that several officials argued for a more explicit statement that the Fed would consider risks to financial stability in determining when and how quickly to raise its benchmark short-term interest rate. In March, the Fed adopted language including "financial developments" among its criteria.
The informal intuition I have in mind is that there is a cost associated with pushing risk premiums too low, because doing so increases the likelihood that they may revert back in a way that hinders the Federal Reserve's ability to achieve its mandated objectives.