Asset bubbles threaten low interest rate policy

In Fed's New Strategy Confronts Old Questions on Financial Trade-Offs, the WSJ's Nick Timiraos writes that a lack of consensus on how to handle asset bubbles might threaten the Fed's commitment to maintaining interest rates near zero.

Dallas Fed President Robert Kaplan and Boston Fed President Eric Rosengren are worried that if rates remain low after the economy recovers from the pandemic, people will be induced to take on more risk since they won't earn a return on their savings. Rosengren, who voted against interest-rate cuts three times last year, is "worried about financial-stability aspects of this policy." He cites examples such as people reaching for yield in commercial real estate and retailers taking on high amounts of debt.

Rosengren and Nellie Liang of Brookings say "it would be easier if Congress granted the central bank or other regulators better macro-prudential tools to address problems such as high levels of indebtedness or the heavy use of short-term borrowings to finance long-term assets."

[Note: this is not really on Congress. In addition to stress tests, which the Fed conducts, macroprudential tools include countercyclical capital buffers, a review of nonbank financial institutions, and limits on loan-to-value ratios. As Liang writes in What are macroprudential tools? (i) the Fed has the authority to set the level of the countercyclical capital buffer, which it kept at zero even during the stronger economy last year, (ii) the Financial Stability Oversight Committee has the authority to designate nonbanks as systemically important but has decided not to "without first evaluating whether the systemic risks could be addressed through more stringent regulations of activities by the primary regulator," and (iii) the Federal Housing Finance Agency has the authority to set maximum loan-to-value (96.5%) and debt-to-income (50%) ratios on home mortgages. In other words, the regulators have the tools, it's more a question of whether they are willing to use them when the economy is doing well.]