* New central bank policymaker highlights easing successes
* ‘Substantial pass-through’ to corporate bond rates -Stein
* ‘Too big to fail’ risk receded recently -Kocherlakota
By Jonathan Spicer
BOSTON, Nov 30 (Reuters) – The Federal Reserve should
continue buying long-term bonds to support economic growth until
the outlook for U.S. employment gets considerably better, Fed
Board Governor Jeremy Stein said on Friday.
Stein, who joined the U.S. central bank in May, defended the
Fed’s unconventional monetary policies on a panel with
Minneapolis Fed President Narayana Kocherlakota, who focused his
comments on regulating big U.S. banks, arguing that the
perceived risk of a failure has receded in recent years.
The Fed has kept short term rates almost at zero for four
years and has bought some $2.5 trillion in bonds to drive down
longer-term borrowing costs and boost the recovery from
recession.
Stein argued that these policies have not only brought down
rates on long-term government bonds, but also have made it
cheaper for corporations to borrow in capital markets.
“While this is not entirely uncontroversial, my own reading
of the evidence is that there has also been substantial
pass-through to corporate bond rates,” Stein, who was a Harvard
finance professor before joining the Fed, said at a conference
hosted by the Boston Fed bank.
He estimated an additional $500 billion on Treasury
purchases would lower long-term bond rates in the government and
corporate markets by around 0.15-0.20 percentage point.
The effectiveness of the “pass-through” of the Fed’s
aggressive policies have been a hot topic since the central bank
launched a third quantitative easing program in September,
dubbed QE3, to buy $40 billion in mortgage bonds per month.
Policymakers could decide to ramp that up when they meet in
Washington on Dec. 11-12.
While some have bemoaned the very incremental reduction in
rates on home loans since QE3, others such as Stein and
Kocherlakota, argue that every bit of support from the Fed helps
in spurring economic growth and lowering the 7.9 percent
unemployment rate.
Stein expressed frustration with the “constraint” lenders
are showing in, for example, issuing mortgage loans.
He admitted that the impact of purchasing assets tends to
diminish over time because, in a weak economic environment,
companies opt to lower their funding costs by refinancing rather
than make new investments.
Still, Stein argued the Fed’s strategy of buying
mortgage-backed securities was particularly effective in helping
the housing finance sector.
“I suspect that mortgage purchases may confer more
macroeconomic stimulus dollar-for-dollar than Treasury
purchases,” Stein said.
The U.S. economy expanded 2.7 percent in the third quarter,
but growth is expected to be significantly slower for the last
three months of the year. Consumer spending posted its first
drop in five months during October, according to a report on
Friday.
TOO BIG TO FAIL
Turning to the Fed’s other key function, financial
regulation, Kocherlakota highlighted that studies using measures
of market risk, including credit default swaps, show “that the
size of the too-big-to-fail problem has fallen over the past
couple of years but remains large.”
While the perceived risk of a big U.S. bank failure has
receded, more study is needed to understand whether the
improvement is due to government policies or simply an improved
economic outlook.
For any given financial institution “it could be that
creditors believe that there is little likelihood of that
financial institution becoming distressed” perhaps because new
rules require banks to put up more capital, Kocherlakota said.
It could also be that creditors believe a government bailout
is unlikely, suggesting that other policies – such as the
requirement banks devise blueprints for a wind-down should they
become insolvent – are working.
But metrics could be improving “simply because creditors’
assessments of future macroeconomic conditions improve,” he
said.
Teasing apart the reasons for the improvement in the
too-big-to-fail problem is key to understanding whether
approaches like those enshrined in the 2010 Dodd-Frank financial
reform act are having the intended effect, Kocherlakota said.
The wide-ranging law, written in response to the 2007-2009
financial crisis, aims to reduce the likelihood of banks failing
and to lessen the cost to society if they do.
Kocherlakota has urged the Fed to adopt guideposts for
policy in terms of unemployment and inflation, and on Friday
reiterated his view that without such metrics “it is challenging
to know whether monetary policy is overly accommodative or not.”
The same point can be made for the too-big-to-fail bank
problem, which Congress has set out to resolve.
“The public can only hold Congress and its (delegates)
responsible for achieving this mandate if there are quantitative
measures of the size of the too-big-to-fail problem,” he added.
(Additional writing and reporting by Pedro Nicolaci da Costa
and Ann Saphir. Editing by Andre Grenon)
