Fed’s Mester: Monetary Policy Is Second-Line Defense Against Bubbles

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In a speech that didn’t comment on monetary policy outlook, Federal Reserve Bank of Cleveland President Loretta Mester said Monday U.S. officials need to be aware what impact ultra-low rates are having on the banking sector.

Ms. Mester, whose comments came from a speech at a conference in Reykjavik, Iceland, also didn’t comment on the economic outlook. Instead, her speech was largely an overview of research on banking-related issues.

Ms. Mester said in her speech that it is better for authorities to use regulatory and supervisory powers to deal with final imbalances, rather than monetary policy.

“I would opt to use the macroprudential tools as the first line of defense, since they can be more targeted to the markets and institutions where the risks are emerging,” she said.

But the official added, “I do think that when we are making policy decisions, we should be cognizant of the linkages between our non-conventional monetary policy of an extended period of essentially zero interest rates and financial stability.”

Ms. Mester also said breaking up the biggest banks has limits to financial stability.

“I remain skeptical that breaking up the banks, however well intentioned, will be effective,” Ms. Mester said.

“Indeed, if the scale economies are large, size restrictions would create great incentives for firms to try to evade the restrictions by moving activities outside of the more regulated sector without necessarily reducing systemic risk,” she said.

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