Monetary policy can only go so far to boost financial stability, Federal Reserve Chair Janet Yellen explained Wednesday during the inaugural Michel Camdessus Central Banking Lecture at the International Monetary Fund in Washington, D.C.
Central banks should balance a "macroprudential" approach, or an evaluation of the overall health and vulnerability of the financial system, with monetary policy to promote a stable economy, Yellen said.
"Such an approach should focus on 'through the cycle' standards that increase the resilience of the financial system to adverse shocks and on efforts to ensure that the regulatory umbrella will cover previously uncovered systemically important institutions and activities," she said.
To support her case for the use of macroprudential policies, including regulatory limits on leverage and short-term funding, Yellen cited a few international examples in which economies have debated how to balance monetary and macroprudential policies to promote financial stability.
"For example, Canada, Switzerland, and the United Kingdom have expressed a willingness to use monetary policy to address financial stability concerns in unusual circumstances, but they have similarly concluded that macroprudential policies should serve as the primary tool to pursue financial stability."
She highlighted the incentives that have come along with using an accommodative monetary policy stance, such as allowing businesses and households to take on potentially productive investment risks, but recognized that risk-taking could contribute to fragility in the financial system.
Still, Yellen said she doesn't see a need for monetary policy to shy away from the status quo, which is focusing on price stability and maximum employment through the Fed's bond-buying program and by keeping the federal funds rate near zero percent.
"That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach," she said.
What do you think? Is it time for the Fed to raise interest rates?
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