Federal Reserve Governor Lael Brainard told a Brookings audience today that “financial stability is more important than ever to the work of the Federal Reserve Board.” In the event hosted by the Hutchins Center & Fiscal and Monetary Policy, Governor Brainard—former undersecretary of the Treasury for international affairs and a former Brookings vice president—addressed the Fed’s macroprudential tools, saying that “While the Federal Reserve has an inherent responsibility for financial stability”:
it has an incomplete set of authorities and a limited regulatory perimeter in a financial system that has large capital markets and a fragmented regulatory structure. It is therefore important that we actively utilize the tools under our authority—which place particular emphasis on building structural resilience at the largest, most complicated institutions through tougher through-the-cycle standards, along with broad countercyclical measures to limit the buildup, and potential consequences, of risks to financial stability, while exploring the design of time-varying sector-specific tools, and, at times, looking to monetary policy as a powerful tool that unlike any other operates across the entire financial system.
In the event—moderated by Hutchins Center Director David Wessel, a senior fellow at Brookings, and including former Federal Reserve Vice Chair Donald Kohn, the Robert S. Kerr Senior Fellow at Brookings—Governor Brainard explained four pillars that support the work of safeguarding the stability of the financial system, as provided by the Dodd-Frank Act of 2010:
- “Surveillance of the possible risks that could threaten financial stability.”
- Building “resilience of firms and markets and to counter risks early enough to prevent disruptions to financial stability that could damage the real economy.”
- “Working across the regulatory perimeter,” including sharing assessment of risks with other financial authorities.
- Monetary policy, which she described as “a powerful tool with broad reach, but also relatively blunt.”
“While recognizing [monetary policy’s] powerful effects,” she added, “there are good reasons to view monetary policy as the second line of defense. It is better viewed as a complement to rather than an alternative to macroprudential tools. In many circumstances, standard monetary policy and financial stability considerations will reinforce one another.”
“If, in the future, the United States did face … financial imbalances … growing rapidly against a backdrop of subpar economic conditions,” she said, “the Federal Reserve may consider monetary policy for financial stability purposes more readily than some foreign peers because our regulatory perimeter is narrower, the capital markets are more important, and the macroprudential toolkit is not as extensive.”
Governor Brainard also made the point that “We need to have a very clearly differentiated, tiered approach to regulation.” She explained that:
Our regulations are very clearly targeted to risks to the system. And those institutions that are large, that are complex, that have big trading activities, that are big relative to the market, that are internationally very active—those institutions have … materially different expectations than regional banking organizations or community banks which are actively in the market providing credit right now. And I think that differentiation is absolutely appropriate.
What we learned from the crisis is those large institutions need to carry materially greater capital, need to have much deeper liquidity buffers because their business model is much riskier and the potential damage from a misstep, from a failure, is so much more sweeping.
“I think we can get that differentiation increasingly right over time,” she said.