WASHINGTON Good bank supervision is the best wait to limit risks to the financial system, but monetary policy can be used to promote stability in rare instances, Federal Reserve Gov. Jeremy Stein said Wednesday.
"If we were to see signs that banks' capital ratios were in danger of eroding, we would certainly want to do something, but it's hard for me to imagine that the something should involve monetary policy," Stein said in a speech at the International Research Forum on Monetary Policy in Washington. "The obvious first line of defense in this case would be to turn to our regulatory and supervisory tools."
Stein who reiterated his support for looking to the bond market for signals of financial excess said that as long as there is a reliable way to measure leverage, the best way to handle to potential vulnerabilities is through a regulatory or supervisory approach.
However, regulators in recent months have become increasingly concerned that a low interest rate environment could hurt the financial system as banks "reach for yield." They have also noted that certain supervisory tools have limited ability to stifle risk.
That is why in some instances the Fed could consider raising interest rates to help mitigate financial risks, given the ability of higher borrowing costs to get "in all of the cracks," Stein said in a speech last year. His comments Wednesday echoed his remarks from that past speech.
Stein has consistently raised concerns about potential harms from the Fed's easy money policies. He has also been a leading thinker about the relationship between monetary policy and financial stability. He will be stepping down in May to return to Harvard University as an economics professor.
The Fed has kept its key interest rate between zero and 0.25% since December 2008. It began easing its stimulus program late last year, but it has pushed off the possibility of raising rates into the distant future.
Meanwhile, speaking in New York on Wednesday, Fed Chair Janet Yellen stressed the importance of making effective monetary policy decisions by taking into consideration "significant unexpected twists and turns the economy may take."