Low U.S. interest rates were not the sole cause of the housing bubble, a top Federal Reserve official said on Wednesday, adding that ultra-low interest rates are appropriate now.
If we take a good hard analytical look at the last recovery, we see that the low fed funds rate was not the standout, and standalone, culprit that many assume, Boston Federal Reserve Bank President Eric Rosengren told a Global Interdependence Center conference in Philadelphia.
This is a crucial matter to consider right now, when rates are very low -- in my opinion, totally appropriately -- because some are predicting that these rates will fuel another bubble.
Many analysts argue the Fed kept interest rates too low for too long in the past recovery, fueling the housing bubble whose bursting sent global financial markets into turmoil.
The Federal Reserve cut interest rates to near zero in December 2008 to combat that turmoil and has pledged to keep them ultra-low for an extended period.
Generally speaking, lower interest rates lead to higher prices for a wide variety of assets, but they do not necessarily lead people to expect continued increases in asset prices - that key characteristic of a bubble, Rosengren, a voting member of the Fed's policy-setting panel this year, said.
He also cited examples in other nations, such as Ireland and Spain, where house prices sky-rocketed. Germany, which had the same monetary policy as Ireland and Spain, did not experience a dramatic increase. All this makes it difficult to root an explanation for the bubble entirely in the choices made by U.S. monetary policymakers, Rosengren said.
Systemic risk regulation would be a better way to lessen problems bubbles can cause, Rosengren said. Forward-looking, stress test-style analysis that looks across the financial system could have done a better job of identifying potential risks from a bursting bubble, Rosengren said.
While we may not be able to eliminate all bubbles, we should be able to limit the degree to which the financial sector feeds and propagates these booms, he said.
Rosengren said that some public reporting of interconnectedness would provide the public with a useful understanding of the risks inherent in the institutions, markets, and systems on which they rely.
Rosengren argued the Federal Reserve is best suited to this type of regulatory role.
Its role as 'lender of last resort', its responsibility for bank supervision and its constant monitoring of the economy provide the Federal Reserve with a unique window on financial-stability issues, he said.
The recent crisis reinforces this point, he said.
No one is happy with the current state of the economy, Rosengren said. But the Federal Reserve's efforts to help maintain financial stability have averted much worse outcomes, he said.
Rosengren's comments come as Congress debates regulatory reform proposals, some of which would strip the Fed of its supervisory role.
Senate Banking Committee Chairman Christopher Dodd has been expected to unveil revised financial reform legislation this week, with a possible vote by the banking panel in mid-March and Senate floor action in April or May.
The reality is that supervisory policies should not be independent of monetary policy and similarly monetary policy should not be conducted without the valuable insights gained from supervision of large and small banks, he said.
Supervisory powers provide an important alternative tool to traditional monetary policy as a way to address bubbles, Rosengren said.
(Reporting by Kristina Cooke, Editing by Chizu Nomiyama)