Commentary Type

One Fed Member’s Swing to Outspoken Dissenter Challenges the Central Bank's View on Bubbles


What should investors make of the rather surprising hawkish dissent from the Federal Reserve Bank of Boston’s once-uber dovish president, Eric Rosengren?

Unlike the fairly predictable votes of the other two naysayers at the central bank’s September meeting, Kansas City Fed President Esther George and her counterpart at the Cleveland Fed, Loretta Mester, Rosengren’s call for an interest rate increase when the Federal Open Market Committee was voting to hold rates steady raised some eyebrows.

A closer look at Rosengren’s own research into the subject of whether monetary policy can and should target asset bubbles helps reveal part of the reasoning for his change of heart. It also shows his vote flies directly in the face of accepted Fed orthodoxy, even post-crisis—that monetary policy should be a last line of defense against asset bubbles. Raising interest rates just to tame markets when the broad economy is weak risks tipping it into recession, goes the prevailing thinking, shared by Fed Chair Janet Yellen.

However, bucking that consensus and putting his vote where his mouth is, Rosengren, after expressing worries that commercial real estate prices may be climbing too quickly in parts of the country, a view reaffirmed in the Fed’s semi-annual testimony on monetary policy.

"There are reasons to believe that financial stability should be an explicit consideration of monetary policymakers,” Rosengren wrote in a paper published late last year.

He doubles down in just-published research, arguing the Fed already effectively does so in its policy deliberations.

This is an entirely different rationale for raising interest rates than the central bank's dual mandate of low inflation and maximum employment. It's also very much a minority view, shared by George of the KC Fed but not many others. Even San Francisco President John Williams, who has been advocating rate hikes lately, has strongly argued against the idea of raising interest rates to tackle asset bubbles in his own research. 

"Monetary policy is poorly suited for dealing with financial stability concerns, even as a last resort," argued Williams in a May 2015 speech.

Yellen also happens to share that perspective, if not quite as categorically. “Monetary policy faces significant limitations as a tool to promote financial stability,” she argued in a 2014 speech.

The Fed's credibility, already hurt by a lack of regulatory fortitude before the financial crisis, has been further damaged during the recovery by repeated—and erroneous—forecasts of an imminent pickup in growth that would require higher interest rates. 

Instead, rather than the promised "gradual pace" of interest rate increases, officials were barely able to sneak in a single rate increase back in December 2015 before worries about the economy, domestically and overseas, again derailed their plans. This is part of a repeated pattern that has seen policy makers start the year with optimistic forecasts for US gross domestic product to finally rebound to a more historically-consistent 3 percent rate, only to settle quite happily by year end for barely a 2% increase.

Inflation too, has undershot the Fed's official 2% target for over four years running. That trend, along with a labor market that has improved but is still far from healthy, makes the heated internal debate about the need for tighter monetary policy rather baffling—particularly when it comes from officials who until recently were vocally concerned about subpar economy. 

The U.S. central bank has left official interest rates near zero since late 2008, when it was responding to a financial and economic emergency of historic proportions. Since then, a weak economic rebound with little help from austere U.S. fiscal policy has not given policy makers room to, as some misleadingly call it, “normalize.”

In a statement explaining his dissent, Rosengren did not cite commercial estate prices specifically, but he did allude to them by nodding to risks of “potentially increasing financial-market imbalances.” That’s pretty much Fed-speak for asset bubbles.

Rosengren’s shift from being one of the most dovish, pro-stimulus voices on the Federal Open Market Committee to becoming a dissenting hawk is not unprecedented. Former Minneapolis Fed President, Narayana Kocherlakota, made a similar transition in the opposite direction, moving from the more hawkish end of the spectrum to becoming a dissenting dove. Given that inflation will continue to undershoot the Fed’s target for its own foreseeable horizon, Kocherlakota’s change of direction has proven to be on the right side of history. It remains to be seen whether the same will be said of Rosengren’s.

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