(Reuters) - Monetary
policy faces "significant limitations" as a tool to counter financial
stability risks, Federal Reserve Chair Janet Yellen said on Wednesday, adding
that heading off the U.S. housing bubble with higher interest rates would have
caused major economic damage.
Weighing
in on a global debate, Yellen reiterated her view that regulation - not rate
policy - needs to play the lead role in combating excessive financial
risk-taking.
"The
potential cost ... is likely to be too great to give financial stability risks
a central role in monetary policy discussions," Yellen said at an event
sponsored by the International Monetary Fund.
She didn't
close the door entirely, however, and she cited some areas that bore monitoring
with an eye toward a possible tightening of regulation.
Analysts said
Yellen was pushing back against some Fed officials who believe financial
stability should be given a more prominent place in formulating monetary
policy.
Jeremy Stein,
who stepped down as a Fed governor in May, had sparked the debate by arguing
higher rates should at least be considered to help stamp out possible asset
bubbles, and a number of regional Fed bank presidents have warned of the
dangers of keeping rates near zero for too long.
But Yellen
made clear she did not see a need for the U.S. central bank to alter its
current course. "I do not presently see a need for monetary policy to
deviate from a primary focus on attaining price stability and maximum
employment," she said.
HAND-WRINGING
The U.S. stock and bond markets have soared
on the back of the Fed's money-printing and near-zero rates, prompting warnings
from some economists that new bubbles are forming. The IMF said last month a
prolonged period of ultra-low U.S. rates - they have been near zero since late-2008
- had prompted a weakening in lending standards and risky behavior by
investors.
For her part, Yellen pointed to unusually
narrow corporate bond spreads, a lack of financial volatility and weak lending
standards in the leveraged-loan market as areas of concern.
"It is critical for regulators to
complete their efforts at implementing a macroprudential approach to enhance
resilience within the financial system," she said.
Yellen said building a stronger system was
all the more important because economies around the globe could be in need of
historically low rates for some time to come, whether due to scars from the
financial crisis or deeper underlying economic shifts.
Because of that, central banks could run
out of room to cut rates more frequently when financial shocks hit, she warned.
Yellen cited a number of steps the United
States had taken to strengthen its financial sector, including setting higher
capital requirements for banks.
In making her case that regulation should
be in the forefront of fighting financial stability risks, she harkened back to
the mid-2000s, when U.S. housing prices were soaring.
Yellen argued a "very significant
tightening" of monetary policy would have been needed to stop the housing
bubble from building, and that the cost would have been a very large increase
in unemployment.
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Related: BIS
Warns About Destabilizing Interest Rates.