The Federal Reserve’s policymaking committee shouldn’t use interest rates to help financial markets, the president of the Minneapolis Fed said Friday, weighing in on an argument that’s been percolating since the 2008 downturn.
Narayana Kocherlakota said it would be difficult to come up with a quantitative measurement of what constituted stability in asset markets and for policymakers to know what to do when that measurement wasn’t met.
“Adding a financial stability mandate would likely generate more public uncertainty about policy choices and economic outcomes,” Kocherlakota said at a conference hosted by the Boston Fed.
At the meeting, the president of the Boston Fed, Eric Rosengren, released a paper that showed how the members of the Fed’s policymaking committee discuss financial stability quite frequently and that interest-rate decisions are influenced by those discussions.
Rosengren, who like Kocherlakota is one of the dovish Fed chiefs who prefers to keep interest rates low to boost employment, called his paper “an initial foray into this area … but it does capture I think the way we seem to behave.”
Congress has given the panel, known formally as the Open Market Committee, two mandates for consideration when determining rates: controlling inflation and employment. Over time, the Fed has defined those mandates with targets that help investors and the public understand its likely decisions.
Since the 2008 financial crisis, which many argue was triggered by rates that created incentives for banks and home lenders to take greater risks, a debate has grown about whether a formal mandate on financial stability should be set for the Fed.
Kocherlakota said the decision of whether to add a third mandate to the Fed committee rests with Congress. But he said the “potentially large costs have to be weighed against whatever benefits might be identified.”
He also recommended steps the Fed could take to clarify its likely actions when considering inflation and employment. For example, while the Fed has laid out a 2 percent inflation goal, Kocherlakota noted it hasn’t specified a time frame for hitting it.
He suggested one: “Two years is a good choice for a benchmark because monetary policy is generally thought to affect inflation with about a two-year lag.”
Reuters contributed to this report.