Tags: federal reserve | interest rates | financial | stability

Fed Economists: Low Rates Could Undermine Financial Stability

Friday, 05 September 2014 08:55 PM

Monetary policy accommodation to help the economy may backfire by creating conditions that could undermine financial stability and cause sharp downturns, according to a report by two top Federal Reserve researchers.

Central banks “should consider effects on both financial conditions and financial stability when setting monetary policy,” according to a preliminary paper by Tobias Adrian, an economist at the Federal Reserve Bank of New York, and Nellie Liang, director of the Fed’s Office of Financial Stability Policy and Research in Washington.

“Accommodative monetary policy eases financial conditions, but may also contribute to the buildup of financial vulnerabilities and hence increase risks to financial stability,” Adrian and Liang write in a paper released Sept. 2.

Fed officials have said they are monitoring markets for signs of unsustainable asset-price increases and excessive risk- taking after they’ve held the main rate near zero since December 2008. Chair Janet Yellen told lawmakers July 16 that she views maintaining financial stability and guarding against crises an “unwritten third mandate” alongside Federal Reserve Act requirements to ensure price stability and full employment.

Adrian and Liang write that the basis for their argument “is a growing body of research advancing a risk-taking channel” of monetary policy.

“This literature suggests that in non-crisis periods when the economy is expanding, accommodative monetary policy interacting with financial frictions can lead to a buildup of financial vulnerabilities,” they write. “Vulnerabilities, such as compressed risk premiums, and excessive leverage or maturity and liquidity transformation in the financial system, can increase the probability of a financial crisis and severe recession in the future.”

Tobias is head of the New York Fed’s Capital Markets Function. Liang’s department coordinates financial stability research on potential threats to the banking system and monitors the financial markets for developing risks.

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Monetary policy accommodation to help the economy may backfire by creating conditions that could undermine financial stability and cause sharp downturns, according to a report by two top Federal Reserve researchers.
federal reserve, interest rates, financial, stability
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2014-55-05
Friday, 05 September 2014 08:55 PM
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