Tags: Cochrane | Fed | policy | regulation

U. Chicago's Cochrane: Fed Has to Guard Against Policy Overreach

By Dan Weil   |   Wednesday, 28 Aug 2013 08:07 AM

There is a danger that the Federal Reserve will try to control too many aspects of the financial system, thereby making it less stable, says John Cochrane, a business school professor at the University of Chicago.

"The really big question is whether and how the Fed will pursue a 'macroprudential' policy," he writes in The Wall Street Journal.

"This is the emerging notion that central banks should intensively monitor the whole financial system and actively intervene in a broad range of markets toward a wide range of goals including financial and economic stability."

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For example, Fed Governor. Sarah Bloom Raskin believes the central bank could prevent bubbles through "capital regulation, liquidity regulation, regulation of margins and haircuts in securities funding transactions and restrictions on credit underwriting."

That's a bad idea Cochrane, says. "This is not traditional regulation — stable, predictable rules that financial institutions live by to reduce the chance and severity of financial crises," he argues.

"It is active, discretionary micromanagement of the whole financial system. ... The science of 'bubble' management is, so far, imaginary," Cochrane adds.

"We need a robust financial system that can tolerate 'bubbles' without causing 'systemic' crises," he explains. "Sharply limiting run-prone, short-term debt is a much easier project than defining, diagnosing and stopping 'bubbles.' That project is a hopeless quest, dripping with the unanticipated consequences of all grandiose planning schemes."

Some commentators think the Fed already has gone too far in its easing campaign and welcome the idea that the central bank may taper its quantitative easing (QE) starting as soon as next month.

But Joe Fahmy, managing director of Zor Capital, doesn't expect tapering to begin before Fed Chairman Ben Bernanke leaves office Jan. 31. The economy isn't strong enough to justify curbing QE yet, he tells Yahoo.

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