* Tarullo sees some areas where risks are building
* No need to change monetary policy at the moment
* Better framework needed to weigh economic, financial risks
* Debate heating up on financial stability risks
By Douwe Miedema
ARLINGTON, Va., Feb 25 The Federal Reserve's top
regulator said on Tuesday that the U.S. central bank should not
rule out using monetary policy to combat asset price bubbles
that potentially threaten financial stability.
Weighing into a long-standing debate, Fed Governor Daniel
Tarullo, the central bank's point person on financial
supervision, said regulatory tools might not be enough on their
own to prevent the formation of economically damaging bubbles.
"In reviewing the relationship between financial stability
considerations and monetary policy ... monetary policy action
cannot be taken off the table as a response to the build-up of
broad and sustained systemic risk," Tarullo, who has a permanent
vote on monetary policy but rarely talks publicly about it, told
the National Association for Business Economics.
More than five years of near-zero Fed interest rates and
trillions of dollars in asset purchases have raised concerns
that the central bank may need to tighten policy before
achieving its economic goal of preventing asset bubbles.
Tarullo said that while investors are taking on more risks
in high-yield corporate bonds and leveraged loans, for example,
there was no need to change monetary policy at the moment.
But he urged the Fed to establish a better framework to
judge trade-offs between enhancing financial stability and
reducing economic activity, before risks grew more urgent.
Incorporating such considerations into policy decisions does
not require a new, formal mandate in addition to the Fed's
congressionally-set goals of price stability and sustainable low
unemployment, Tarullo added.
At a policy-setting meeting last month, "several" Fed
officials suggested that financial-market risks, such as
asset-price bubbles, should be an explicit consideration as they
consider when to finally raise rates.
MORE WORK ON REGULATION
Five years after the collapse of Lehman Brothers, regulators
need to do more to ensure the biggest U.S.-based banks are safe
and taxpayers are protected from costly bailouts, Tarullo said.
"I don't think that we're at, or even really close to, the
point at which we can say, 'Okay, now we can be pretty
comfortable that along the spectrum of concerns we've come far
enough that we're hitting about the right trade-off.'"
An unsustainable build-up of leverage in mortgage assets on
Wall Street sparked the 2007-2009 financial crisis. A flurry of
subsequent rule-making is meant to reinforce the financial
system, but some worry that the Fed's unprecedented easy-money
policies could fuel another damaging bubble.
"While ad hoc supervisory action aimed at specific lending
or risks is surely a useful tool, it has its limitations,"
Tarullo said, citing the "strong inflows" in the corporate bonds
and leveraged loans that raise "the possibility of large losses
He said the Fed is closely watching the risks posed by its
easy monetary policies "particularly given the possibility that
interest rates may remain historically low for some time even
after" policymakers begin to raise them.
"Our monitoring does find some evidence of increased
duration and credit risk, but the increases appear relatively
moderate to date - particularly at the largest banks and life
insurers," he said.
Based on published forecasts, the central bank plans to halt
its bond-buying later this year and start to raise rates some
time in 2015, as long as the economy continues to expand and
unemployment continues to drift lower.