I disagree with this piece. But, it is well laid out and argued – which makes it a good piece! So let us go through the reason why I take issue:
1) They are advocating one tool, many targets.
If the excess becomes a systemic threat, the Fed should then address it through its (existing) powerful interest-rate levers.
Although they seem to do this for nice enough reasons:
We are not advocating expanding the Fed’s tool kit and do not think the Fed should micromanage the economy.
It still doesn’t make sense. They are trying to assume away some of the costs directly inherent in trying to get the US Fed to do what they want, by just not giving them the tools to do it! The number of tools needs to be equal to the number of targets (here, wiki of Tinbergen), so if you aim to target some functional relation of financial stability as well as inflation we need these macroprudential tools!
Admitting this, and ensuring the institutional structure is appropriate for the given tools and targets is important. When discussing having monetary policy and financial stability policy it was justifiably stated on VoxEU that:
Institutionally, it can be advantageous to assign both policies to the same authority, namely the central bank. However, safeguards are then needed to counter the risks of dual objectives, and institutional frameworks should distinguish between the two policy functions, with separate decision-making, accountability and communication structures.
2) The suggest attacking bubbles as part of an employment mandate – as a popping bubble lowers employment
Yet when financial excesses are building and not accompanied by inflation or unemployment, the Fed is unlikely to act. We need not accept this inaction. Fed governor Jeremy Stein, who has been writing on bubbles, said this summer that deflating a bubble would be consistent with the goal of promoting full employment because a bursting bubble affects employment.
Is the Stein argument a good one? Is the Borio argument a good one?
It appears a growing number of central bankers think so as well.
But I find it uncompelling as it is confusing policy related and unpolicy related costs from bubbles! A bubble ‘pops’, implying that some people that purchased the asset at a higher price lose out – this is NOT policy relevant. A bubble ‘pops’, people default, a bank is about to fail and drag everyone down with it. This is a concern. But understanding why the other banks are not sufficiently insured against this failure, and why a bank is fragile to the “popping of a bubble” that is supposedly so obvious is important here – the ideas of systemic risk, and the fact that current regulations act as a subsidy on borrowing for banks is the main issue here. NOT the popping of some ‘bubble’ itself.
So far the only argument I’ve seen for directly targeting bubbles is “its obvious, look at the crisis”. This is a bad argument.
Note, none of what I’m saying disagrees with this:
we were almost unanimously blind to the risks of rising housing prices and bank leverage
But it just states that we should think about where the issue, and concern, with systemic risk comes from. It is the idea that, in the face of a shock, our financial system would fall over – a financial system that won’t be allowed to fail, and in turn is willing to take on excessive risk. Our solution should be based on this itself – not using interest rates to target financial stability. And in practice this still doesn’t make any sense unless we are willing to stick our neck on the line with a “model” of the bubble, and an ability for ex-ante identification, which can be used to make the policy action transparent!
And it doesn’t really disagree with this:
The simplest way to encourage Fed governors to be vigilant for excesses is to make maintaining financial stability explicitly part of the Fed’s mandate. This would have two effects. First, governors would be required to search, proactively, for imbalances. In essence, Fed officials would have to approach the economy from a different perspective than would most Americans.
Except that I ask us to think about this more carefully. If we are mandating a specific regulatory role, why do we have to mix it up with monetary policy? Why can’t we simply have two organisations with independence and a mandate signed by the finance minister. Hell, make it three organisation and do it with tax as well 😉
The fact is that financial stability is a different role. Yes monetary policy (and fiscal policy) influence it, but it is a separate target. If we justify a target on public policy grounds, and if that target is subject to dynamic inconsistency, and requires clear communication, then we SHOULD have a clear independently set mandate for an independent organisation on that basis. That is the kicks.
And for financial stability this is the real big kicker for me – can we at least make an attempt to come up with a clear target and to justify it on policy grounds. Rather than throwing around heaps of nifty ex-post justifications for doing things, which inherently lead us to move towards discretion, political interference, and micromanagement 😉