Monetary policy is not an effective tool for pricking asset bubbles, but central banks without authority to supervise banks may have no alternative, Chicago Federal Reserve President Charles Evans said Tuesday.
Evans made the comments as reform proposals move forward in Washington to strip the Fed -- the U.S. central bank -- of supervisory authority over small banks. The reforms would add to the Fed's role in supervising large financial institutions.
Regulatory reforms designed to prevent a repeat of the financial crisis, which was fueled by asset bubbles, should give central banks a supervisory and regulatory role so they have additional tools to promote financial stability, he said, according to the prepared text of a speech in Hong Kong.
A central bank, because it is the lender of last resort, should have a role in promoting financial stability, he said.
If, however, central banks have no supervision and regulation tools, they are constrained to act with the only tool at their disposal - monetary policy, he said.
But because monetary policy is such a blunt tool for pricking asset bubbles, he said, using it to do so could put pressure on a central bank to raise rates faster than otherwise would be called for to ensure full employment and price stability.
A central bank with three goals and only one lever is a recipe for producing some difficult policy dilemmas, he said.
What to do with central banks' supervisory authority is just one aspect of necessary regulatory reform, Evans said. Reforms should also put in place some kind of systemic risk manager that can spot small problems that on their own pose little risk but in the aggregate threaten the entire financial system, he said.
Our goal clearly is to avoid another crisis of this magnitude, he said.
We need a multi-pronged approach to a robust regulatory structure: a structure that takes full advantage of the existing tools supervisors have; a structure that supplements the existing one with dynamic capital requirements and a comprehensive approach to risk management; a structure that includes a macroprudential supervisor than can monitor and assess incipient risks across institutions and markets and, when necessary, impose higher regulatory requirements on firms that pose systemic risks, he said in the text.
While such a structure should help prevent financial stress, he said, regulators also need to establish a resolution authority able smooth an potential wind-down of a systemically important financial institution, he said.
(Reporting by Ann Saphir; Editing by Andrew Hay/Ruth Pitchford)