Macroprudential Regulation: Fantasy versus Reality

Monetary Policy and Financial Stability

“In my remarks, I will argue that monetary policy faces significant limitations as a tool to promote financial stability: Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment. As a result, I believe a macroprudential approach to supervision and regulation needs to play the primary role. Such an approach should focus on “through the cycle” standards that increase the resilience of the financial system to adverse shocks and on efforts to ensure that the regulatory umbrella will cover previously uncovered systemically important institutions and activities. These efforts should be complemented by the use of countercyclical macroprudential tools, a few of which I will describe. But experience with such tools remains limited, and we have much to learn to use these measures effectively.

I am also mindful of the potential for low interest rates to heighten the incentives of financial market participants to reach for yield and take on risk, and of the limits of macroprudential measures to address these and other financial stability concerns. (Emphasis Added) Accordingly, there may be times when an adjustment in monetary policy may be appropriate to ameliorate emerging risks to financial stability. Because of this possibility, and because transparency enhances the effectiveness of monetary policy, it is crucial that policymakers communicate their views clearly on the risks to financial stability and how such risks influence the appropriate monetary policy stance. I will conclude by briefly laying out how financial stability concerns affect my current assessment of the appropriate stance of monetary policy.”

Bloomberg’s Opinion in my previous post seems to echo Ms. Yellen’s beliefs. Higher overnight interest rates cause severe economic damage. Better to use “macroprudential regulation” to prevent financial bubbles and crises. My skepticism arises from many incentives. Last year, the top 25 hedge fund managers made $615 million. Hedge Fund Manager Pay Hedge funds underperformed market indices. Now I can only find dated reporting regarding Private Equity pay. Private Equity Pay The median average for the top eight PE CEOs was $139 million in 2016.

Macroprudential regulation requires regulators. For the record, Chairman Powell of the Federal Reserve earns a maximum compensation of $252,500. FRB Pay Scale shows the salaries for those under Chairman Powell. In what fantasy land does our central bank believe regulators will hold billionaires and their entourage accountable? Tomorrow I will discuss Bernanke’s debt forgiveness relying on the total opposite argument: Low interest rates increase wealth which increases GDP. And yet, he never mentions debt growth in the outer years.

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