By Steven K. Beckner

JACKSON HOLE, Wyo. (MNI) – Charles Bean, deputy governor of the
Bank of England, expressed concern Saturday about unrealistic
expectations of what monetary policy can accomplish.

Meanwhile, Bundesbank President Axel Weber said that governments
must come to grips with their practice of considering major financial
institutions “too big to fail” if central banks are to be able to
conduct monetary policy normally.

The two European central bankers were participating in a discussion
of macroeconomic policy challenges at the Kansas City Federal Reserve
Bank’s annual symposium.

Bean, in a paper presented to the symposium earlier, argued that
central banks should get back to targeting short-term interest rates as
soon as possible and leave behind such unconventional policies as asset
purchases.

Former Fed Vice Chairman Alan Blinder, one of the paper’s
discussants, didn’t disagree. But he doubted whether that will be
possible anytime soon.

Noting that the Fed’s policymaking Federal Open Market Committee
voted to return to quantitative easing by reinvesting proceeds of
maturing mortgage backed securities in Treasury securities, Blinder said
the FOMC “made a first baby step” back toward quantitative easing.

And he added, “it won’t be the last. That’s my prediction.”

Friday, in his keynote address to the symposium, Fed Chairman Ben
Bernanke made clear the Fed is prepared to provide monetary stimulus,
possibly through net new asset purchases, if the outlook deteriorates
“significantly.”

The monetary policy discussion at the Kansas City Fed conference
was taking place at a time of record federal budget deficits which are
seen as limiting governments’ flexibility to provide additional fiscal
stimulus. That leaves monetary policy as “the only game in town” to
support economic growth, but that makes central bankers somewhat
uncomfortable.

Bean warned against monetary policy “being asked to do more than
its capable of,” saying that is “storing up trouble for ourselves in the
future.”

Bean argued that monetary policy must be supplemented by
“macroprudential” regulatory policies, such as bank capital
requirements, to contain future asset bubbles and prevent future
financial crises.

But Weber suggested that central banks will continue to have
trouble in the future avoiding boom-bust scenarios so long as
governments continue to treat certain firms as “too big to fail.” He was
skeptical whether recently enacted financial reform legislation has
settled that issue.

Weber was reacting to comments by former Undersecretary of Treasury
John Taylor, who said that Fed bail-outs of Bear-Stearns and others were
“quite damaging” and also questioned the effectiveness of unconventional
monetary policies pursued after the crisis erupted.

Taylor alleged that, during the run-up to the crisis, the Fed had
gotten away from “the framework that works” — a “Taylor Rule”
prescribing changes in short-term rates relative to economic growth and
inflation targets — and held rates too low, thereby contributing to the
housing price bubble. He urged a return to that framework as soon as
possible.

Weber said that “even if intervention in a crisis is not very
effective, but still had to be done to prevent systemic consequences.”

Weber said there must be “a future focus on too big to fail
issues … . We have to be able to wind down these institutions in order
not to have monetary policy involved.”

“The key focus should on too big to fail,” Weber went on. “Crisis
management does not just have short-term effects. It has long-run
effects.”

“To get back to normal monetary policy, we have to deal with too
big to fail,” Weber added.

Bean said that, in making policy during a boom, central banks
shouldn’t “focus on asset price alone” but also on the expansion of
credit and bank leverage.

He disagreed with Taylor’s contention that excessively low interest
rates earlier in the decade were a major factor in causing the boom and
bust. He agreed with Bernanke’s contention that monetary policy played
only a “modest” role.

But Bean said that “even if you have only a modest effect on credit
growth (by raising rates) it might well be worth pursuing” to curb
“marginal borrowers.”

In his paper, Bean said “the case for ‘leaning against the wind’ by
setting policy rates higher during the boom seems stronger than before.”
But he added, “at least most of the time monetary policy does not seem
like the most appropriate instrument to call on … . The deployment of
macro-prudential instruments … seems more appropriate.”

Fed officials have also argued for using monetary policy in
coordination with macroprudential regulations.

Taylor warned that such an approach “will take monetary policy in
the wrong direction in the coming decade.” He warned against making
monetary policy “highly discretionary” and tolerating “large deviations”
of interest rates from the levels implied by Taylor-type policy rules,
which call for the federal funds rate to be raised when inflation or
output exceed target.

“Unorthodox polices would be called upon because they are thought
to work — incorrectly in my view,” Taylor said.

Bean disagreed with Taylor’s warning about making monetary policy
“more discretionary.” He said he just wants to “develop a more
macroprudential tool kit” and “let monetary policy get back to what it
does best.”

Henry Kaufman, head of an economic consulting firm bearing his
name, said “the Fed always had prudential responsibility … . Now it is
more explicit” under the financial reform act.

“It has to work with monetary policy,” said Kaufman. “The Fed’s
role has to be a coordinated role between prudential side and monetary
side.” Agreeing with Weber, Kaufman said “the overriding issue is one
of too big to fail. That problem of too big to fail has not been fully
addressed in the legislation.”

“The issue underlying it is the correct allocation of credit,”
Kaufman continued, noting that during the housing boom large
institutions “excacerbated the misallocation of credit.” And he added,
“there is no evidence it is going to be rectified in the future.”

-more- (1 of 2)

** Market News International **

[TOPICS: M$$CR$,M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$,M$$BE$,MI$$$$,M$$EC$]