Brainard Says Monetary Policy a Secondary Stability Defense

Federal Reserve Governor Lael Brainard said monetary policy can be a “second line” of defense to preserve financial stability, and regulators need to rely on building resilience at the largest banks.

The Fed has limitations that “should lead us to be circumspect regarding the use of monetary policy as a tool to address financial stability risks,” Brainard said at a conference in Washington today.

Brainard, 52, who this week is giving her first public speeches since joining the Fed in June, focused on tools the central bank has to increase stability across the financial system. The Fed “is seen as the agency with the broadest sight lines across the economy and one that has some important stability tools, as well as a critical first responder when a crisis hits,” she said at the Brookings Institution.

Brainard, asked in a question-and-answer session about volatility that shook financial markets in mid-October, said the Fed carefully monitors such episodes.

Regulators are “going back and doing very detailed analysis of the data to understand whether in fact there may be some structural vulnerabilities, which may be associated with new regulations,” Brainard said. “They may be associated with technology, with new kinds of trading and higher-frequency trading. So we are looking at possible areas that could prove to be a structural vulnerability.”

On Oct. 15, the U.S. Treasury market had its biggest yield fluctuations in a quarter century.

Market Volatility

The Treasury’s Office of Financial Research said in its annual report yesterday that severe market volatility could occur again. The OFR said fire sales of assets, the Russia-Ukraine crisis and excessive risk-taking driven by low interest rates all pose potential threats to financial stability.

Referring to the Fed’s range of tools to address financial stability, “there are good reasons to view monetary policy as the second line of defense,” Brainard said in her speech. “It is better viewed as a complement to rather than an alternative to macro-prudential tools.”

She said it’s “important that we actively utilize the tools under our authority -- which place particular emphasis on building structural resilience at the largest, most complicated institutions.”

While the central bank has “an inherent responsibility for financial stability, it has an incomplete set of authorities and a limited regulatory perimeter,” she said.

Fed Limitations

Fed Chair Janet Yellen said in July that monetary policy “faces significant limitations as a tool to promote financial stability.”

Brainard, a former Treasury Department undersecretary for international affairs, also said the Fed’s stress tests on large banks “are powerful tools for building resilience in our largest banking firms,” even as they have some limits on gauging the strength of lenders.

Brainard, noting that the Fed has authority to set margin requirements for repurchase agreements and securities-financing deals, said “there is some interest in exploring whether imposing minimum margin requirements on additional forms of securities credit could prevent margins from compressing during booms.”

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