June 5, 2014 / 2:46 PM / 4 years ago

Fed's Williams floats tools to address financial stability risks

June 5 (Reuters) - Using monetary policy to try to reduce the financial system’s vulnerability to shocks poses real and “sizable” risks, a top Federal Reserve official said on Wednesday, but at least two new approaches hold promise and merit further study.

One such approach calls for the central bank to act to keep nominal income growth on a steady path, San Francisco Federal Reserve Bank President John Williams said in remarks prepared for delivery to the Deutsche Bundesbank Conference Housing Markets and the Macroeconomy: Challenges for Monetary Policy and Financial Stability.

So-called nominal income targeting can help avert bankuptcies and foreclosures, which can worsen financial crises, he said.

A second approach is to make interest-bearing accounts more broadly available than just through banks, reducing the incentive of private institutions to rack up short-term debt that can contribute to financial instability, he said.

“I am not personally advocating either of these proposals, but I do view them as creative ways to think of how to bend the curve in terms of macroeconomic and financial stability tradeoffs,” Williams said.

Such approaches, he said, differ from the conventional idea of using monetary policy to head off asset bubbles or respond to looming risks. Although approaches involve tradeoffs and could have unintended consequences, they merit further study because they hold out the promise of ensuring a more stable financial system without undermining the central bank’s main aims of stabilizing prices and boosting the economy.

The experience in Norway and Sweden, he said, suggests the pitfalls of a more conventional approach to using monetary policy to deal with financial stability concerns. There, such an approach has led to a potentially harmful reduction in inflation expectations, he said.

“Anchoring inflation expectations and responding in a systematic way to economic developments are by far the most important elements of good monetary policy,” Williams said.

Reporting by Ann Saphir; Editing by Chizu Nomiyama

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