Fed at odds with itself with rules and rates

Federal Reserve policymakers seem to be working at cross purposes

In laying out plans to ease some constraints imposed on banks after the financial crisis, the Fed is moving to free up tens of billions of dollars for financial institutions to lend to promote faster economic growth.

At the same time it is reducing its balance sheet and gradually raising interest rates to restrain credit creation and keep the economy in check.

“The timing is not the most opportune” for relaxing the banking rules, said Mark Zandi, chief economist at Moody’s Analytics Inc in West Chester, Pennsylvania.

Those steps will complicate the Fed’s effort to engineer the soft landing of an economy that is already being juiced by tax cuts and government spending increases. To help bring that about, officials plan to keep raising interest rates over the next few years, though they’re expected to hold policy steady at their meeting next week. “By itself this would risk putting regulatory policy on the same pro-cyclical trajectory as fiscal policy,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, though he added that the economic impetus from the former is dwarfed by that from the latter.

A more efficient financial system enhances the Fed’s ability to affect the economy via changes in interest rates, while the normalisation of monetary policy helps smaller banks by allowing them to earn more profits on their loans, Quarles told an economic conference in Washington on April 18.

Some of his colleagues are not so sure and question whether the Fed’s regulatory actions are appropriate at a time when stock and other asset prices are showing signs of froth.

“While we should carefully consider how to make our regulations more effective and better tailored, we must take great care to ensure that we do not inadvertently contribute to procyclicality that would exacerbate financial conditions that are, on some dimensions, somewhat stretched,” Fed Governor Lael Brainard said in an April 19 Washington speech. Brainard, a Democrat, voted against the plan to ease leverage limits for Wall Street banks. Quarles and Fed Chair Jerome Powell, both Republicans, voted in favour.