News Column

Federal Reserve chief: Monetary policy can't guarantee stability

July 2, 2014

Washington (Alliance News) - Interest rate adjustments are not the appropriate tool to stabilize financial markets, Federal Reserve Chairwoman Janet Yellen said Wednesday.

In a speech at the International Monetary Fund, Yellen urged central banks around the world to rely more on building resilience in their financial systems.

"Monetary policy faces significant limitations as a tool to promote financial stability," Yellen said. "Its effects on financial vulnerabilities ... are less direct than a regulatory or supervisory approach."

The Fed has kept its benchmark interest rate at an unprecedented near-zero since December 2008, though the central bank has signaled that modest tightening could be on the horizon in 2015. Yellen said the easy monetary policy aided the US economic recovery but warned that low rates encouraged the flight of money to more risky practices.

"Such risk-taking can go too far, thereby contributing to the fragility in the financial system," she said.

Yellen conceded that experience with supervisory and regulatory tools such as countercyclical policy - known in central banking as macroprudential policy - is "limited, and we have much to learn" to use those tools effectively.

She noted that Canada, Switzerland and Britain have concluded that the so-called "macroprudential policies" should serve as the primary tool for supporting financial stability.

In contrast, Norway and Sweden have taken only limited steps in that direction, relying instead on interest rates to address stability concerns.

After the US and global financial crisis of 2008-2009, spawned by US banks dabbling in a class of high-risk mortgage bonds, the US Congress passed the Dodd-Frank Act to bring about sweeping changes in financial regulation.

The law requires banks and other financial organizations to hold larger capital buffers and undergo periodic stress tests. Applicants for new mortgages, for example, undergo more stringent review than before the crisis.

While US interest rate policy will continue to be tailed to balancing price stability and full employment, Yellen said, she noted "pockets of increased risk-taking across the financial system" that could require a "more robust macroprudential approach."

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Source: Alliance News

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