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Fed's Williams: Monetary policy not the tool for preventing crises

[SINGAPORE] A top Federal Reserve official on Thursday dove into the simmering global debate over how best to protect against future financial crises, arguing that interest rate hikes are not the answer, even as a last resort. "Despite the clear need to consider all potential tools to avoid a financial crisis, I am unconvinced that monetary policy is one of them," San Francisco Fed President John Williams said in remarks prepared for delivery at a symposium on Asian banking and finance in Singapore. "While the costs of using monetary policy to address financial stability risks are clear and sizable, the potential benefits of such actions are much harder to pin down." Although a few Fed policymakers explicitly argue that the Fed ought to raise rates soon to discourage the kind of risk-taking that can lead to financial instability, most US central bankers, including Fed Chair Janet Yellen, are skeptical about using rate hikes to head off asset bubbles.

Mr Williams' remarks Thursday mark some of the strongest comments on the public record by a US central banker against that strategy, especially in the context of a weak economy. "Monetary policy is poorly suited for dealing with financial stability concerns, even as a last resort," he said.

Norway and Sweden have both tried using rate hikes to protect against financial instability, and the result was a rise in unemployment and an unwanted slowdown in inflation, Mr Williams said.

While low interest rates are seen as fostering excessive risk-taking, it is unclear, he said, whether the right monetary policy response would be to jack up rates quickly to tamp down further risk-taking, or to take a gradual approach to avoid market disruption. "The ambiguous effects of monetary policy on financial stability are another argument for limiting use of this tool," he said.

Macroprudential tools, such as changes to market structure and stress tests used to assess risks posed by more than one bank to the system as a whole, are a useful approach, he said, but are still under development in the United States.

For the foreseeable future, Mr Williams said, policymakers will need to rely on so-called microprudential tools - the careful supervision and regulation of individual banks - to ensure financial stability.