MNI POLICY: Market Reform Needed Amid Strong Rebound-Rosengren

The U.S. economy appears poised for a strong rebound, but a "hot" economy could pose financial stability challenges and policy makers would be well-served to consider options that would avoid the market ructions last March when Covid hit, Boston Federal Reserve President Eric Rosengren said Monday

The U.S. economy should experience a significant rebound this year, said Rosengren, who is expecting it will take two years to reach pre-pandemic levels, adding there are some continuing concerns with coronavirus variants.

Unemployment and labor force participation rates will fall back to pre-pandemic levels "over the next couple of years," Rosengren said in prepared remarks for a Newton-Needham Regional Chamber of Commerce speech. But Rosengren, who is not a voting member of the FOMC this year, said despite the very strong forecast, labor-market slack is still significant and inflation is still below the Fed's 2% target.

The current highly accommodative stance of monetary policy "is appropriate," he said, adding that the revised monetary policy framework adopted by the FOMC in August means policymakers can be more patient and wait for further tangible signs that inflation has increased, rather than just forecasts, before starting to raise rates.

BOLSTERING FINANCIAL STABILITY

But risks to the upside are present, he said, as the amount of fiscal and monetary stimulus is much greater now than in previous cycles and these upside risks could pose some financial stability issues when the next recession occurs.

He said structural risks remain from last March, and he pointed policymakers to prime and tax-exempt money market funds, Treasury market reforms, and advocated for a countercyclical capital buffer.

Emergency Section 13(3) facilities should not have been needed to rescue money funds last year, he said, and a potential remedial action would be to require all MFs to adopt swing pricing, which is currently voluntary.

On the Treasury market, a structure less reliant on broker-dealers' balance sheets to maintain liquid markets for these securities would be an option, he said, and, echoing comments made to MNI in November, this could be done by creating central clearing mechanisms for Treasuries and the financing of Treasuries.