–Updating Story Published 13:21 ET; More Quotes, Detail
By Steven K. Beckner
KANSAS CITY (MNI) – New Kansas City Federal Reserve Bank President
Esther George suggested Tuesday that hers will be a voice of caution on
monetary policy.
George, in her first public speech since succeeding Thomas Hoenig
last Oct. 1, said monetary policymakers must “walk a fine line” and
avoid encouraging financial institutions to take excessive risks, which
could lead to “distortions” and financial instability later.
She suggested that, because of the very low interest rate
environment which the Fed has fostered, there may already be some
“mispricing of risk.” Like Hoenig before her, she cited as an example
the “dizzying” rise in Midwest farmland prices.
So she said that she intends to “weigh the costs and benefits” of
future Fed actions in remarks prepared for delivery to the Central
Exchange.
Though not a voting member of the Fed’s policymaking Federal Open
Market Committee this year, she will be contributing to the quarterly
forecast of the federal funds rate beginning at the Jan. 24-25 FOMC
meeting.
George, who will turn 54 on Sunday, did not flatly say she will
oppose further monetary easing as Hoenig consistently did in the latter
years of his long tenure as head of the Tenth Fed district. But she did
strongly suggest she will take a very cautious approach to doing so. And
she emphasized that monetary policy must work in concert with financial
regulation.
Like her colleagues, the former bank examiner and supervisor
acknowledged that “the pace of the recovery has been slow, and threats
to the recovery loom large” and so “monetary policymakers find
themselves in uncharted waters.”
But “as policymakers search for solutions to the considerable
challenges of the day, it is necessary to weigh the potential costs and
benefits of future actions,” she said. “After all, the crisis has
reminded us of the severe consequences that can occur when risk is not
priced appropriately.”
“As we look ahead and manage through those consequences, achieving
a balanced and sustained recovery will require difficult, but necessary,
adjustments,” she said. “The challenges before monetary policymakers
remain considerable,” she added, “especially so given the degree to
which the FOMC’s normal policy tools have been used during and following
the crisis.” She said, “Traditional monetary policy tools have been
exhausted, and unconventional tools are now in play.”
“As policymakers consider additional options and possible actions,
it is necessary to appropriately weigh their costs and benefits,” she
said.
She asked, “how can policy enable and encourage the financial
system to undertake prudent risk-taking that has been temporarily
suppressed by the recession and slow recovery while preventing the
recurrence of poorly allocated resources and mispriced risk that
contributed so significantly to this most recent crisis?”
Elaborating on her monetary policy philosophy and drawing on her
supervisory experience, George recalled that past expansions have “led
to mispriced risk and overinvestment” that have led to “irreparable
loss” for many people.
Recalling her days as a bank examiner during the 1980s, she said
banks by the hundreds failed in the midwest as a boom in agriculture,
energy and real estate came to a devastating end because “investors and
bankers had mispriced the riskiness of assets in those sectors, and it
took years for the region to recover.”
“Here we are again,” she said in reference to the fact that the
economy is now struggling to recover from a burst housing bubble.
Past experience should be an object lesson for current
policymaking, George suggested at a time when many of her Fed colleagues
are suggesting that urgent action, including further purchases of
mortgage backed securities be taken to push down already low mortgage
rates and speed the housing recovery..
“Policy choices that attempt to speed improvement in the housing
and labor markets can be attractive given these circumstances,” she
said. “But this desire must be traded off against the need to foster
long-term stability within our financial sector.”
“While appropriate risk-taking is fundamental to banking and
desirable in this environment, creating conditions that encourage the
financial system to take on mispriced risk could lead to distortions
that will only haunt us later,” she warned.
Already, in the Midwest, George observed, “farmland values are
soaring to unprecedented levels. Each week brings a new tale of dizzying
prices at the most recent farmland auction. I hear from many
well-informed, concerned voices across our region wondering whether this
could be a bubble.”
So George, who did a stint running the Federal Reserve Board’s
Division of Supervision and Risk Management, said “it is within this
context that I approach my role in monetary policy and contemplate the
path ahead.”
“I view monetary policy as attempting to walk a fine line,” she
said. “On the one hand, today’s policy settings are designed to
encourage risk-taking and to stimulate much-needed growth across our
economy. But on the other hand, experience has shown that pushing
risktaking too far can cause the mispricing of risk, the misallocation
of capital and the ultimate weakening of financial firms’ balance
sheets.”
“Our policy tools must be managed as complements,” she stressed.
“Macroeconomic and financial stability are too interconnected to
separate cleanly. Monetary policy and supervision must work in tandem if
we hope to achieve maximum employment and price stability, the goals
given to us in the Federal Reserve.
In comments on the economy, George said the recovery has been
“uneven and underwhelming.”
Even after “temporary factors” have ebbed, “a considerable drag on
the recovery remains the consequences of the buildup in leverage leading
to the financial crisis.”
George said “the housing market has shown some signs of
stabilization, but activity remains very weak,” and she suggested this
is reinforcing the sluggishess of the overall economy.
“Even now, two-and-a-half years into the recovery, consumer
confidence remains at low levels,” she said. “In this vicious cycle, a
weak economy and weak housing values reduce household income and wealth,
which in turn weighs on consumer spending, which causes businesses to be
cautious, which impedes the economy from achieving a rapid recovery.”
The financial sector is “less-than-healthy” as well, she said.
“Although U.S. banks have been reporting increasing net income since
2009, this improvement mostly is related to a reduction in loan loss
provisions … . Problem loans remain at historically high levels.”
“All of this suggests a moderate recovery remains the most likely
outlook, depending on developments in Europe and Asia’s economies, as
well as U.S. fiscal policies that have yet to be defined,” she said.
** Market News International **
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