Observations on Financial Stability Concerns for Monetary Policymakers
Shanghai Advanced Institute of Finance, Beijing, China
Speaking at a conference in Beijing, Boston Fed President Eric Rosengren said it has been appropriate to be patient about normalizing interest rates, given that growth “has continued to underwhelm.” But the Fed’s mandated goals – stable prices and maximum sustainable employment – are likely to be achieved relatively soon, and “keeping interest rates low for a long time is not without risks.”
As a result, important questions confront monetary policymakers in the United States, including when and how quickly to continue normalizing interest rates.
Central banks must think about attaining their mandates “not only at the current time, but also through time” – weighing the benefits of low interest rates now against the potential costs in the future of possibly spurring instability.
Firms and households faced with long periods of low returns may react by “reaching for yield” – buying riskier assets than one would otherwise in order to archive a desired profit or savings goal, Rosengren said. “Should a large negative shock occur, firms and households would be exposed to greater losses through their holdings of riskier assets than they would be if they were not reaching for yield.”
He noted that in the United States, a potential side effect of very low interest rates has been rapid price appreciation in the commercial real estate sector.
Exploring the potential risks of the increase in commercial real estate prices, Rosengren said that if the U.S. economy were to weaken, and underlying occupancy rates and rents became less favorable, a large decline in commercial real estate collateral values could lead to losses for banks.
This scenario, while not his prediction, would have downstream effects on credit availability to firms and households.
“In my view, commercial real estate is, by itself, unlikely to trigger financial stability problems. But should prevailing economic conditions change in response to a large negative economic shock, commercial real estate prices could decline relatively quickly, leading to large losses at leveraged firms.”
Rosengren said that because commercial real estate debt is widely held by depository institutions, commercial real estate losses could erode banks’ capital ratios and lead to a contraction of credit availability for firms and households – similar to the credit crunch experience in the early 1990s.
“The financial stability concerns that could arise from a low interest rate policy continuing for an extended period of time should be considered in conjunction with how best to achieve” the central bank’s full employment and price stability goals, “now and over time,” Rosengren concluded.