Central Bank Independence: Growing Threats

The median FOMC participant forecasts that the Committee will raise the target range for the federal funds rate three times this year. That is, by the end of 2017, the range will be 1.25 to 1.50 percent. Assuming the FOMC follows through, this will be the first time in a decade that the policy rate has risen by 75 basis points in a year. It is natural to ask what sort of criticism the central bank will face and whether its independence will be threatened.

Our concerns arise from statements made by President-elect Trump during the campaign, as well as from legislative proposals made by various Republican members of Congress and from Fed criticism from those likely to influence the incoming Administration’s policies....

Steve Cecchetti and Kim SchoenholtzJanuary 2, 2017Monetary policy, Financial stability, Time consistency, Central bank independence, Macroprudential policy, Delegation, Democracy, Transparency, Accountability, Lender of last resort, Fiscal dominance, Policy rule, Gold standard

Monetary Policy and Financial Stability

In June 2015, a committee of Federal Reserve Bank Presidents conducted a “macroprudential tabletop exercise”—a kind of wargame—to determine what tools to use should risks to financial stability arise in an environment when growth and inflation are stable. The conventional wisdom—widely supported in policy pronouncements and in a range of academic studies—is that the appropriate tools are prudential (capital and liquidity requirements, stress tests, margin requirements, supervisory guidance and the like). Yet, in the exercise, the policymakers found these tools more unwieldy and less effective than anticipated. As a result, “monetary policy came more quickly to the fore as a financial stability tool than might have been thought.”

This naturally leads us to ask whether there are circumstances when central bankers should employ monetary policy tools to address financial stability concerns. Making the case for or against use of monetary policy to secure financial stability is usually based on assessing the costs and benefits of a policy that "leans against the wind" (LAW) of financial imbalances...

Kim SchoenholtzNovember 14, 2016Macroprudential policy, Leaning against the wind, Financial stability, Monetary policy, Interest rate policy, Credit imbalances, CHOICE Act, FORM Act, Regulation, Systemic risk, Stress test, SIFI, Orderly Liquidation Authority, Loan-to-value requirement, Capital requirements, Liquidity requirements, Margin requirements, Supevision

Commentary

Money, Banking, and Financial Markets