Fed’s Mester says further study needed of monetary policy’s affect on financial stability

(Reuters) – The Federal Reserve’s new approach to monetary policy should help the central bank influence the economy at a time when interest rates and inflation are low, but policymakers need to study how low rates can affect financial stability risks, Cleveland Fed Bank President Loretta Mester said Wednesday.

The framework clarifies that strong employment on its own is not a concern to the Fed unless there are strong inflationary pressures or financial stability risks, Mester said. But there are situations where low rates could encourage “higher levels of borrowing and financial leverage, increased valuation pressures, and search-for-yield behavior,” she said.

“While monetary policy that leads to a stable macroeconomy encourages financial stability, it is also possible that in an environment with low neutral rates, a persistently accommodative monetary policy could, in some cases, increase the vulnerabilities of the financial system,” Mester said in remarks delivered during a virtual event on monetary policy.

“How best to approach the nexus between monetary policy and financial stability in a low-interest-rate world deserves more consideration,” Mester said.

During the panel, Mester said more work needs to be done to understand structural issues in markets that could make them more or less resilient during times of stress. She also said she is not concerned about the Fed’s emergency lending facilities crowding out markets because the programs are set up as backstops.

The policymaker also said the Fed has more work to do in helping the public understand monetary policy and to better influence inflation expectations.

 

A survey taken shortly after the Fed unveiled its new framework found that more people said the goal of monetary policy was to lower government borrowing costs, and fewer were aware of the central bank’s goals for price stability and maximum employment, Mester said.