CRAPO STATEMENT AT MONETARY POLICY HEARING

Thank you, Mr. Chairman.  Welcome, Chair Yellen. 

 

During Dr. Yellen’s nomination hearing, I noted the need to fill additional vacancies at the Federal Reserve Board with individuals bringing balanced viewpoints.  The President should nominate someone with community bank experience to the Board to fill one of the remaining vacancies.  Community banks play an important role in their local economies and face a disproportionate burden from regulation.  We should ensure that the perspective of these banks is represented in regulatory policymaking. 

 

Today’s hearing is another important opportunity to discuss monetary policy and financial regulatory policy.  Since our last hearing with Chair Yellen, the Fed has continued to reduce the pace of its large scale asset purchases, known as quantitative easing, or QE.  It has been a welcome development to see that under the Chair’s direction, this process of tapering has begun and that we will likely see all QE purchases cease later this year.

 

I have consistently made my opposition to the policy of QE clear.  The quadrupling of the size of the Fed’s balance sheet that has occurred as a result of the Fed’s QE purchases of Treasury and agency-backed mortgage-backed securities is worrisome.  These QE assets will remain on the Fed’s balance sheet for a very long time, and the reserves used to purchase them will remain in the financial system. The process of normalizing monetary policy could be difficult, particularly in light of the fact that our economy has failed to strengthen in the way that was promised by the supporters of this unconventional monetary stimulus.

 

Recent Federal Open Market Committee (FOMC) minutes indicate that in the coming years, any miscommunication about monetary policy during this normalization period could create risks to the economic outlook.  Continued clear communication will be important, particularly as the Fed is seeking to rely on new tools that are unfamiliar to the market.

 

For example, Fed officials have indicated that overnight reverse repurchase agreements, also known as repos, will likely play a large part in setting monetary policy during normalization, while the Federal funds rate may become less important.  At the FOMC meeting, some raised concerns that the Fed’s overnight repo facility could increase problems during adverse market conditions, potentially causing counterparties to shift funds away from making loans and opting for the Fed’s safety net instead.

 

How will the Fed balance the need for open communication with the ability to preserve flexibility, should unintended consequences arise in this important market? 

 

I am also interested in your recent comments on the use of “macroprudential” tools by the Fed.  You specifically recognized that experience with these tools is limited and that many central banks still “have much to learn to use these measures effectively.” 

 

Introducing the concept of managing U.S. monetary policy by regulations and prudential oversight is untested and perhaps more theoretical than practical.  I agree with those who are concerned that regulators may not be able to get the timing right.  Many economists, including those at the Fed, have not been very good judges of identifying market bubbles and predicting when the bubbles will burst.

 

Your speech discussed the ability of regulators to change regulatory standards on mortgage lending, such as debt-to-income and loan-to-value ratios, as a macroprudential tool that could slow mortgage lending.  I am very skeptical that during a housing boom regulators would ever act aggressively to restrict lending to individuals with high levels of debt or low incomes.  In fact, recent experience suggests that all the political pressures run counter to that happening.

 

It is also highly questionable to think that forecasters will identify beforehand when these tools should be adjusted during the credit cycle.  While financial stability can complement the goals of monetary policy, it is paramount that the regulators strike the right balance without unduly harming the economy.  

 

Again, welcome and I look forward to your testimony.