Monetary, Fiscal, and Financial Stability Policy Tools: Are We Equipped for the Next Recession?
March 23, 2018
Tenth Conference of the International Research Forum on Monetary Policy
International Research Forum
Speaking in Washington, D.C., Boston Fed President Eric Rosengren suggested that policymakers should view financial stability tools more holistically, and assess the ability to utilize fiscal, monetary, and financial stability policy tools to respond to a hypothetical adverse shock.
Noting that the last financial crisis underscored the role financial instability can play in disrupting the economy and slowing its recovery, Rosengren said that now is the time to assess and strengthen the various policy tools available to respond to an adverse shock.
Unfortunately, Rosengren said, rather than building sufficient capacity for possible downturns (which he stressed he is not predicting), in his view the U.S. has actually seen a reduction in the capacity of so-called "buffers" across the policy tools.
"Policymakers need to think about and act on creating greater capacity and flexibility within the tools currently available – including those most directly related to financial stability."
The Federal Reserve's monetary policy buffer, Rosengren said, has been depleted as the nominal equilibrium interest rate in the United States has fallen. Simple math suggests that given prevailing low rates, policymakers could quickly run out of room to lower the federal funds rate – and so the ability of conventional monetary policy to respond to a crisis is somewhat constrained.
"I believe that policymakers should consider adjusting the monetary policy framework, to address the possibility that the capacity of conventional policy tools may be too quickly depleted," Rosengren said.
He noted that fiscal policy buffers are being bolstered in some European countries as their economies improve, but that the same cannot be said for the United States.
"My view is that U.S. fiscal policy we have seen since the crisis emerged in 2008 will simply give future policymakers less flexibility to respond to a hypothetical large financial stability shock with fiscal policy tools," Rosengren said.
Should a shock occur, monetary policy and fiscal policy may not be expected to respond as forcefully as they did in the last financial crisis and its aftermath.
This highlights how important it is that financial stability tools "provide sufficient buffers." These tools include altering the scenarios used in the bank stress tests that are applied to the largest banks, and the setting of the Countercyclical Capital Buffer.
He noted that the Countercyclical Capital Buffer remains at zero, and said that with asset valuations high a non-zero buffer can be justified.
"In my view, now should be the time that policymakers carefully consider this state of affairs, and assess which tools could provide more potent buffers to draw upon should a large adverse financial shock occur," Rosengren concluded.
"While that is not my expectation or prediction, my view is that it is an opportune time to prepare for such a possibility."
Rosengren was delivering keynote remarks at the tenth conference of the International Research Forum on Monetary Policy.