Fed's Mester: Central Banks Should Focus on Regulation

Central bankers should be aware of the potentially destabilizing effects of super-easy policy on financial systems, a top U.S. Federal Reserve official said on Monday, even if monetary policy should not be used as a main tool to prevent bubbles.

“I would opt to use the macroprudential tools as the first line of defense, since they can be more targeted to the markets and institutions where the risks are emerging,” Cleveland Fed President Loretta Mester said in remarks prepared for delivery to the annual conference in of the Financial Intermediation Research Society, a group she helped found, meeting in Reykjavik, Iceland. “However, I do think that when we are making policy decisions, we should be cognizant of the linkages between our nonconventional monetary policy of an extended period of essentially zero interest rates and financial stability.”

The concern that the Fed’s near-zero rates, in place since December 2008, could be creating new bubbles and an eventual crisis has motivated a few Federal Reserve officials to push for the U.S. central bank to start raising rates sooner than later.  But Mester’s view that the Fed can best prevent a new crisis through regulation and supervision of the banking and financial system is in keeping with that of most of her colleagues, who believe that despite imperfect understanding of financial system risks, monetary policy should be only a second-line defense against bubbles.