The Federal Reserve Board of Governors recently warned of the possibility of excesses in asset markets but concluded that, at least for now, if there is a need to act it will not be done by raising interest rates but by relying on "macroprudential" policy tools to reduce systemic risk.
We are not expressing a view on whether there are current financial excesses that are potentially destabilizing—that is always hard to judge—or whether the Fed should raise rates now to deal with such possible risks. But we do think it imperative that Fed policy makers have a realistic view of the breadth of the possible systemic risks and of the tools that are available to deal with such risks.
The macroprudential tools that the Fed has discussed relate primarily to making banks more resilient, and that is obviously very important. But the possible systemic risks extend to a vast number of other institutions and asset markets, and there the issues around macroprudential regulation become much more complicated.
The Financial Stability Oversight Council, established in 2010 by Dodd-Frank, can give the Fed authority over certain non-banks, and can recommend policy changes to regulators like the Securities and Exchange Commission and the Commodity Futures Trading Commission. But so far the FSOC has taken very limited actions. The Fed's banking regulatory powers may also give the Fed the ability to indirectly affect some other areas of risk, such as hedge-fund positioning, but how much is unclear. Neither the Fed nor any other regulatory body has laid out a comprehensive description of the potential macroprudential tools.