Offering his take on the current state of monetary policy
and financial stability in the U.S. financial system, Michael Barr framed his
perspective as coming from the intersection of his dual roles at the Federal
Reserve – vice chair for supervision for the Federal Reserve Board and as a
member of the Federal Open Market Committee (FOMC) – during a
speaking engagement at the Forecasters Club of New York.
Barr touched on the current economic situation, focusing on
inflation and employment, noting the recent stabilization in inflation and the
corresponding uptick in economic activity, which has exceeded expectations.
“While inflation has been moderating, incoming data on
economic activity have shown considerably more resilience than I had expected,”
Barr said in prepared remarks. “We are being helped by improvements in supply.
I now see a higher probability than I did previously of the U.S. economy
achieving a return to price stability without the degree of job losses that
have typically accompanied significant monetary policy tightening cycles.
However, the historical record cautions that this outcome could be quite
difficult to achieve.”
Barr asserted he remains focused on the risks involved in
achieving both price stability and maximum employment. Noting the relatively
tight labor market and continued growth through August, Barr said efforts are
still underway to improve the balance between labor supply and demand given a
slowdown in job growth but with more people are entering the labor force. He
also attributed the balance to increased immigration and a decrease in job
vacancies.
Barr noted that while most banks would not be subject to the
Fed’s recent “endgame” proposal on bank capital, it would have major effects on
the country’s largest and most complex institutions.
“The bulk of the proposed changes have been a decade in the
making, and, as the name implies, the proposal is the last major plank to
address gaps in regulation dating from the global financial crisis,” Barr
explained. “Since the Federal Reserve Board has just begun to receive comments
on the proposed rules, I cannot say how those rules will evolve, but I can try
to provide more background on why I believe the benefits of the proposal would
outweigh the costs. I will also discuss the importance we place on public
engagement in the rulemaking process to ensure we strike the right balance
between the costs and benefits of our rules.
“The proposal is projected to raise capital for large banks.
This may result in higher funding costs. But this is only half the story.
Capital also enables banks to absorb more losses without risking their ability
to repay their creditors,” he added.
Noting how monetary policy tends to gradually influence the
cost and availability of credit, while financial instability can affect credit
suddenly, Barr asserted both factors impact economic activity, making credit
vital for spending, employment and growth.
Offering a historical perspective, Barr highlighted the
importance of financial stability in the Federal Reserve’s establishment in
1913, a response to the periodic banking sector strains, which led to bank runs
and failures. Financial stability and monetary policy were traditionally
considered separately, but this changed significantly after the global
financial crisis. The Dodd-Frank Act and subsequent reforms strengthened the
banking sector's resilience.
He noted that the increase in capital requirements related
to lending activities in the current proposal is a small portion of the
estimated overall capital increase and the bulk of the rise in required capital
anticipated in the proposed rule is attributed to trading and other activities
besides lending.
The pandemic created an unprecedented imbalance between
supply and demand, causing high inflation. The rapid global tightening of
monetary policy created stresses in the financial system, Barr noted, pointing
out the resulting rising interest rates which strained bank balance sheets in
the U.S. and abroad as evidence of the importance of proper management of
interest rate risk.
A stable financial system is essential for achieving the Fed’s
goals of maximum employment and stable prices. The safety and soundness of the
banking sector is of paramount importance. Additionally, Barr acknowledged the
need to address risks outside the banking sector, as stress in broader
financial markets often affects the banking system.
Check back with Dodd Frank Update for highlights from
Barr’s subsequent speech explaining the relationship between capital and
lending at the American Bankers Association’s Annual Convention in Nashville.