Fed Governor Stein Resigns to Return to Teaching at Harvard

Federal Reserve Governor Jeremy Stein, a thought leader on the linkage between monetary policy and financial stability, resigned from his post to return to teaching economics at Harvard University.

Stein, 53, will leave May 28 after two years as a governor, according to a statement by the Fed today in Washington. His return to Harvard, which doesn’t extend leaves beyond two years, creates a vacancy for his term ending Jan. 31, 2018.

Stein departs amid growing concern among policy makers that more than five years of near-zero interest rates and trillions of dollars in bond purchases may give rise to financial instability.

“He had the intellectual heft to speak with authority on financial-market issues and macroeconomic issues, highlighting the potential risks” from quantitative easing, said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington. “He was a very influential guy. It is a loss for the Federal Open Market Committee and the Board.”

Bomfim added that Stein’s resignation wasn’t surprising given Harvard’s restrictions on leave.

In speeches, Stein described an approach to financial bubbles that included raising interest rates, breaking with colleagues who said supervisory tools should be the first line of defense. While former Chairman Ben S. Bernanke elevated financial-stability concerns, the Fed’s strategy on how and when to manage excess in markets remains unfinished.

Empty Seats

Stein’s exit leaves the Board with just three of seven governor positions filled: Chair Janet Yellen, Daniel Tarullo, and Jerome Powell. Powell is awaiting confirmation for a second term by the Senate. Two other nominees to the board are also awaiting confirmation: Lael Brainard, a former U.S. Treasury undersecretary for international affairs, and former Bank of Israel Governor Stanley Fischer, who would serve as vice chairman.

“Jeremy has made important contributions and served as an intellectual leader during his time at the Board,” Yellen said in a statement today. “His understanding of monetary policy and markets as well as his expertise in banking and financial regulation has proven invaluable.”

Asset Purchases

Even as he expressed concern about financial stability, Stein backed the Fed’s asset-purchase program, which has pushed its balance sheet to a record $4.23 trillion.

“During my time here, the economy has moved steadily back in the direction of full employment, and a number of important steps have been taken to make the financial system stronger,” Stein said in a resignation letter to Obama dated today and released by the Fed. “There is undoubtedly more work to be done on both dimensions.”

Stein challenged the consensus among central bankers that supervisory tools should be the first line of defense against asset bubbles, noting that many segments of the financial markets are beyond the Fed’s supervisory perimeter.

“While monetary policy may not be quite the right tool for the job, it has one important advantage relative to supervision and regulation -- namely that it gets in all of the cracks,” Stein said in a Feb. 7 speech last year in St. Louis.

‘Blunt Tool’

Chicago Fed President Charles Evans last month indirectly referred to Stein’s argument, saying raising rates to permeate the entire financial system with higher borrowing costs “is just another way of saying that raising interest rates is a blunt tool” that could do “immediate damage” to the Fed’s pursuit of full employment and stable prices.

Stein took his argument a step further and said that regulators should consider responding to overheated bond markets with tighter monetary policy, even at the cost of a forecast for higher unemployment, given the damage financial bubbles can do to the overall economy.

“All else being equal, monetary policy should be less accommodative -- by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level -- when estimates of risk premiums in the bond market are abnormally low,” Stein said in a Washington speech on March 21.

Stein sat on the Fed board’s committees on bank supervision and economic and financial monitoring research.

He served in the Obama administration from February to July 2009 as a senior adviser to the Treasury secretary and on the staff of the National Economic Council. He was also a senior staff economist on the Council of Economic Advisers from September 1989 to June 1990.

“Using monetary policy to suppress bubbles maybe loses a little bit of support at the board, but I don’t think that argument will go away just because Stein goes away,” said Roberto Perli, a partner at Cornerstone Macro LP in Washington and a former Fed economist. “He’s not alone.”

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