A general increase in interest rates would not have been as effective at preventing the recent economic recession as better financial regulation would have been, Federal Reserve Chairman Benjamin Bernanke says.
"Although forceful responses by policymakers around the world avoided an utter collapse of the global financial system in the fall of 2008, the crisis was nevertheless sufficiently intense to spark a deep global recession from which we are only now beginning to recover," Bernanke said in a January 3 speech (http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm) to the American Economic Association's annual meeting in Atlanta.
"The crisis revealed not only weaknesses in regulators' oversight of financial institutions, but also, more fundamentally, important gaps in the architecture of financial regulation around the world," the nation's chief banker said.
During 2009 summits in London and Pittsburgh, leaders of the Group of 20 advanced and emerging economies called for ( http://www.america.gov/st/business-english/2009/September/20090927125733dmslahrellek0.1804882.html ) greater regulation and supervision of the financial, banking and investment sectors of the global economy. The U.S. Congress is considering legislation aimed at overhauling financial regulation in the United States.
Bernanke told economists at the gathering that the Federal Reserve has been working to spot problems and to strengthen supervisory policies and practices. The Fed has also advocated substantial legislative and regulatory reforms to address those problems that were exposed by the economic crisis.
Some critics of the Fed have claimed that excessively easy monetary policy and low interest rates in the first half of the decade helped cause a rapid increase in house prices in the United States. The collapse of those prices proved a major source of the financial and economic crisis of the past two years. Bernanke said those who support that criticism have called for a greater role in monetary policy for preventing and controlling bubbles in house prices and other financial assets.
By contrast, Bernanke said, other critics have argued that monetary policy and lower interest rates were appropriate for economic conditions at the time in spurring job creation and getting the economy back to full capacity. The economic policies of the Fed were not the principal cause of the housing bubble or necessarily the tool for controlling the increase in house prices, he said.
"Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates," Bernanke told the economists. "The Federal Reserve and other agencies did make efforts to address poor mortgage-underwriting practices."
Links between low interest rates and the rapid rise of house prices are weak, he said.
"The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter," Bernanke said.
Bernanke is awaiting a vote by the U.S. Senate on his nomination by President Obama for a second term as chairman of the U.S. Federal Reserve. His nomination was approved by the Senate Banking Committee in December 2009, and his reconfirmation by the full Senate is expected before his term ends January 31.
The Fed is working to improve its ability to spot and correct problems in financial institutions, and also to move from a bank-by-bank supervisory approach to one that aims for stability of the financial system as a whole, he said.
"Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets," Bernanke said.
Bernanke said speculative excesses like the housing bubble are not easy to spot in their earliest stages, and applying higher interest rates to quash them can have unintended consequences for the economy as a whole. Part of the problem with house price bubbles is in determining with certainty if they are national in scope or confined to a few rapidly growing local markets, he added.
"Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established," Bernanke said.
"That said, having experienced the damage that asset price bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated," he said.
The Federal Reserve's Federal Open Market Committee meets later this month and is expected to keep its basic bank-lending interest rate at a record low, near zero.