Christopher J Waller: Financial Stability and Macroeconomic Policy
Speech by Mr Christopher J Waller, Member of the Board of Governors of the Federal
Reserve System, at "The Future of Macroeconomic Policy", a conference sponsored by
the Norges Bank, the International Monetary Fund, and the IMF Economic Review,
Oslo, Norway, 16 June 2023.
* * *
I have been asked to talk about monetary policy and financial stability in today's
1
economic environment. The recent stress in the U.S. banking system has brought
these two topics, their interlinkages, and the tools we use to achieve our goals to the
forefront of central bank policy and public discourse. In short, although financial stability
and monetary policy tools are used independently, they are nevertheless
interconnected via their respective effects on the macroeconomy. So let me take a few
minutes to discuss this topic in more detail.
Financial stability is essential for monetary policy in the United States to achieve its
congressionally mandated goals of maximum employment and price stability.
Importantly, stable financial markets and institutions allow changes in the stance of
policy to transmit in a smooth and expected way to the financial conditions that
households and businesses face in making spending and production decisions.
Instability in the financial system, on the other hand, hinders economic activities of
households and businesses, which impedes the attainment of our dual mandate. This is
in large part why the Federal Reserve monitors financial stability risks-to help ensure
that banks, nonbank financial institutions, and financial markets can continue
channeling credit to households and businesses.
But this is a two-way street. Financial stability depends on a healthy economy, and all
else equal is strengthened by monetary policy actions taken to promote our
macroeconomic goals. The U.S. financial system is generally resilient enough to handle
large shocks. However, in March, we saw an instance where this wasn't true. A rapid,
sizable increase in interest rates resulting from persistently elevated inflation
contributed to stresses in the banking system that we needed to address using our
financial stability tools.
Despite the interconnections between maximum employment, price stability, and
financial stability, the tools we use to promote financial stability are separate and
distinct from the tools we use to carry out monetary policy. And, I will argue, that
separation is appropriate, as each set of tools is fit to its respective purpose.
The set of tools the Federal Reserve uses to address financial stability issues is
targeted and surgical. These include bank supervisory and regulatory tools that are
used on an ongoing basis to promote the safety and soundness of individual financial
firms and build a resilient financial system. There are also tools that provide liquidity to
banks and other financial intermediaries in emergencies, such as the discount window
or lending facilities created to extend credit more broadly.
So far, these financial stability tools have had a good track record of effectively
promoting financial stability in the United States. Numerous lending facilities set up in
the spring of 2020 helped limit strains that the pandemic put on the financial system.
More recently, when the failure of Silicon Valley Bank led to the loss of deposits at other
banks, the discount window and a new facility to help ensure banks have the ability to
meet the needs of all their depositors have been effective at containing stresses in the
banking system. Importantly, these actions to address financial stability enabled us to
continue to pursue our monetary policy objectives during these times.
Compared with financial stability tools that address liquidity or other strains in targeted
individual institutions or segments of the financial system, monetary policy affects
everyone and every part of the economy and would be a blunt and less effective tool to
address financial stability problems. That said, in carrying out monetary policy, we do
consider how credit conditions and other factors related to financial stability are
affecting the economy. As I argued in a speech last month, the recent strains in the
2
banking sector may lead to a tightening of price and nonprice conditions for lending. If
that is the case, then it might reduce the need for at least some further tightening of
monetary policy to lower inflation. The Fed could tighten policy too much if it ignored
such a development.
To make this argument more concrete, consider the onset of the pandemic in March
2020. The Federal Open Market Committee held two unscheduled meetings where,
recognizing that the coronavirus would weigh on economic activity and pose risks to the
economic outlook, it lowered the policy target range down to zero. At the same time, the
unprecedented uncertainty about how the macroeconomy would be affected by the
pandemic destabilized financial markets, which led the Federal Reserve to put in place
several lending facilities to support the system. We took each of these actions
independently; we did not lower the policy rate for the sole purpose of achieving
financial stability. Although both types of tools were used simultaneously, they were
used to solve different problems.
Financial stresses in the banking sector are a factor that my colleagues and I are
closely watching as we determine the appropriate stance of monetary policy going
forward. While lending conditions imposed by banks have tightened since March, the
changes so far are in line with what banks have been doing since the Fed began raising
interest rates more than a year ago. That is, it is still not clear that recent strains in the
banking sector materially intensified the tightening of lending conditions.
Let me end by noting that some have argued that the Fed's tightening of monetary
policy was significantly responsible for the failures and stress in the banking system.
They argue we should have taken this into account when setting policy. Let me state
unequivocally: The Fed's job is to use monetary policy to achieve its dual mandate, and
right now that means raising rates to fight inflation. It is the job of bank leaders to deal
with interest rate risk, and nearly all bank leaders have done exactly that. I do not
support altering the stance of monetary policy over worries of ineffectual management
at a few banks. We will continue to pursue our monetary policy goals, which ultimately
support a healthy financial system. At the same time, we will continue to use our
financial stability tools to prevent the buildup of risks in the financial system and, when
needed, to address strains that may emerge.
The views expressed here are my own and are not necessarily those of my
colleagues on the Federal Open Market Committee.
2
See Christopher J. Waller (2023), " Hike, Skip, or Pause? " speech delivered at the
2023 Santa Barbara County Economic Summit, University of California, Santa Barbara
Economic Forecast Project, Santa Barbara, Calif. (via webcast), May 24.