William Dudley, the president of the Federal Reserve Bank of New York, said central bankers must be willing to act under certain conditions to counter asset bubbles, backing regulatory or supervisory tools over monetary policy.
Dudley, during a speech in New York on Wednesday, said monetary policy is not likely to work as well because "it is too broad." He also said that speaking out on the dangers of bubbles as they are forming "would allow the central bank to signal its concern."
"Let me underscore the challenge that central bankers face in combating asset-price bubbles," Dudley said before the Economic Club of New York. "Asset bubbles are hard to recognize in real time and each asset bubble is different. However, these challenges cannot be an excuse for inaction."
Dudley's comments go beyond remarks he made in December, when he said it is "still an open question" whether limiting leverage through regulatory and supervisory means or via monetary policy would be more effective. The Fed's record in the years before the economic crisis has been criticized in Congress, which is considering the most sweeping changes to financial regulation in decades.
The New York Fed president's position on bubbles echoes the stance taken by Fed officials such as Fed Chairman Ben S. Bernanke and Vice Chairman Donald Kohn.
Last month, Kohn said he would prefer to use regulation and supervision, resorting to interest rate increases "only if imbalances were building and regulatory policies either were unavailable or had proven ineffective."
Bernanke, in a January speech, suggested the "best response" to the housing bubble would have been regulatory, not monetary.
"I don't think other Fed speakers have talked too much about using the bully pulpit," said Michael Feroli, an economist at JPMorgan Chase & Co. in New York and a former member of the Fed's research staff. "It shows they don't have a tin ear to the whole topic."
Fed policymakers are trying to spot potential imbalances in the system and determine when to remove monetary accommodation before inflation takes hold.
The legacy of former Fed Chairman Alan Greenspan has been criticized by scholars such as Allan Meltzer since the subprime mortgage market collapsed in 2007. Last year, Greenspan said it was hard for central bankers to anticipate bubbles in "real time," and that he's skeptical that officials can adopt a policy that prevents bubbles from forming without harming other parts of the economy.