The FOMC meeting this week is not likely to see any policy fireworks, but it will mark the departure of Governor Jeremy Stein, who returns to academic life at Harvard at the end of May. He has only been on the Board for two years, but he has made an intellectual mark in a critical area where leading members of the FOMC have been largely silent – how to set monetary policy when the need to maintain financial stability is conflicting with the near term outlook for inflation and employment.
The issue can be simply stated: should the Fed tighten policy solely because they are worried about the emergence of bubbles in asset prices?
After the financial crash of 2008, this should be a subject close to the heart of the new Chair Janet Yellen and her senior colleagues. Up to a point, it is. An enormous amount of attention has been given to the new financial architecture that has followed the crash, and Chair Yellen has already spoken specifically about the importance of too-big-to-fail, and the reform of the wholesale money markets.
Yet the vast majority of the Fed’s recent communication has been on the familiar topics of estimating slack in the labour market, and the consequences of this for inflation. In its statements and minutes, the FOMC has generally given very little attention to the difficult question of how to maintain financial stability and thus avoid the next “Minsky moment”. Read more