Bonds

Federal Reserve Gov. Christopher Waller said the central bank should not reverse course on monetary policy simply because it is having an acute impact on certain banks.

During a speech delivered Friday at the Norwegian central bank, Waller pushed back against the idea that rate hikes were to blame for the failures of Silicon Valley Bank, Signature Bank and First Republic Bank earlier this year.

“The Fed’s job is to use monetary policy to achieve its dual mandate, and right now that means raising rates to fight inflation,” Waller said. “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.”

He said the Fed is closely tracking financial stability conditions. He singled out credit conditions as an acute concern following the failures and said the central bank could moderate its approach to monetary policy if lending tapers off significantly throughout the banking system. But, he noted, there has been no evidence of that yet.

“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,” he said. “That is, it is still not clear that recent strains in the banking sector materially intensified the tightening of lending conditions.”

Waller’s remarks come just days after the Federal Open Market Committee elected to hold its target interest rate range steady for the first time in 15 months. Along with the vote, however, most members of the committee projected that at least one more rate hike would be necessary before the end of the year. 

During his speech, Waller argued that the Fed’s tools for monetary policy and financial stability work in tandem, albeit in different ways. He pointed to the Fed’s discount window and the newly created bank term funding program as being instrumental to stabilizing the banking system earlier this year. That stability, in turn, enabled the Fed to continue pursuing its monetary goals.

“But this is a two-way street,” he added. “Financial stability depends on a healthy economy, and all else equal is strengthened by monetary policy actions taken to promote our macroeconomic goals.”

Despite these interconnections, the Fed does not explicitly factor potential stability implications into its monetary considerations. Instead, it proceeds on the basis that the financial system is strong, and then addresses specific weaknesses when they arise. 

During the Fed’s rate hiking campaign, which began in March 2022, some economists have warned against this approach, arguing that rapid interest rate increases put excessive strain on the financial system. In this spring’s bank failures, those individuals saw their fears coming to fruition

In his speech, Waller defended the Fed’s current approach, noting that the central bank’s financial stability tools — such as supervision and regulation as well as emergency lending facilities — are “targeted and surgical.” Meanwhile, the Fed’s monetary instruments, namely setting interest rates and adjusting its balance sheet holdings, are notoriously blunt.

He highlighted the efforts taken by the Fed at the onset of the pandemic: slashing rates and rolling out emergency lending facilities to support liquidity in the banking system.

“We took each of these actions independently. We did not lower the policy rate for the sole purpose of achieving financial stability,” Waller said. “Although both types of tools were used simultaneously, they were used to solve different problems.”

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