HILSENRATH’S TAKE: FED’S FISCHER KEEPING OPTIONS ON THE TABLE FOR NEXT BUBBLE

The Federal Reserve isn’t worried about financial bubbles disturbing the economy right now. If it becomes worried about bubbles, then its new vice chairman, Stanley Fischer, sounds like an individual who will want to keep his options open in a search for tools to deal with the problem. Interest rates hikes, in some circumstances, might be needed to tame a boom, he says.

Here is the key passage from a speech he gave in Stockholm, Sweden earlier this week:

What can the central bank do when financial stability is threatened? If it has effective macroprudential tools at its disposal, it can deploy those. If it does not itself have the authority to use such tools, it can try to persuade those who do have the tools to use them. If no such tools are available in the economy, the central bank may have to consider whether to use monetary policy–that is, the interest rate–to deal with the threat of financial instability.

As Mr. Fischer makes clear, there can be no one-size-fits-all rule for central banks when it comes to dealing with the threat of bubbles, because central banks have different tools at their disposal. They can all raise interest rates, a weapon they might in theory use to stop a bubble. But they’ve got different regulatory tools at their disposal, meaning their lines of defense will vary.

Case in point: The Bank of England has a Financial Policy Committee with the authority to make wide-ranging regulatory decisions to address bubbles. The Fed is one of many regulators and it needs to work through the Financial Stability Oversight Council to get other regulators to move in concert … no easy task. One central bank might throw more regulatory firepower at a problem than the other before feeling the need to resort to rate hikes.

Mr. Fischer, former governor of the Bank of Israel, had mixed results using regulatory tools to tamp down a housing boom there: “We were very cautious in using these new tools because we did not have good estimates of their strength and effectiveness. Quite possibly, we should have acted more boldly on several occasions,” he said. Adding to the challenge, the measures were unpopular and coordination among regulators was “complicated.”

The Fed has been debating bubbles since the mid-1990s, when then-chairman Alan Greenspan decided it was best to let them run their course and clean up the mess after the burst. Fed chairwoman Janet Yellen argued against using rate hikes to stop them in a speech to the International Monetary Fund in July. As Mr. Fischer makes clear, the central banking community still isn’t settled on what to do when the next one appears.

-By Jon Hilsenrath