The Federal Reserve’s rate-setting committee meets on Tuesday and Wednesday—it almost certainly won’t do anything at all. The central bank surprised investors in September when it decided to postpone reducing its monthly asset-purchases after warning all summer that such a pullback was impending. A taper announcement isn’t expected to come this week either, as concern over weaker-than-expected growth and the impact of the latest fiscal showdown in Congress have Fed governors inclined to stay put.
Even a notorious hawk such as Dallas Fed President Richard Fisher has said he would not support a reduction in the bond-buying program at the Oct. 29-30 meeting, mostly because of the fiscal “mess” in Washington. (Fisher doesn’t currently sit on the Fed’s policy committee, which he will re-join in 2014 when membership rotates.)
The uncomfortable waiting game heightens the risk that low long-term interest rates feed dangerous asset bubbles, as Fisher is always fond to remind his pro-QE peers at the Fed. “I’m beginning to see signs not just in my district but across the country that we are entering, once again, a housing bubble,” the Texas central banker said two weeks ago.
Fisher isn’t the only one who’s been warning of peril. Fed Chairman Ben Bernanke has discussed at length how persistently low rates could lead investors to turn to risky bets in search for better returns or to take on too much cheap debt that they might not, one day, be able to re-pay. The argument for staying the course with the current ultra-lax monetary policies, though, is that central banks can resort to tighter financial market rules and oversight to pierce bubbles and other nascent threats before they grow too big.
Withdrawing monetary stimulus when the economy is still weak “would likely result in higher unemployment and a sharp decline in asset prices, choking the moderate recovery,” Chicago Fed President Charles Evans said in recent remarks. Anything that raises interest rates, in other words, is like a bazooka: It will flatten bubbles—and everything else along with them, including economic activity. Financial regulation, on the other hand, is a precision rifle that lets one aim at specific problems.
But Fed officials talking up the virtues of regulation might want to take a close look at how Canada’s attempt to pull off that feat is—or rather, isn’t—turning out. Four rounds of mortgage rules tightening, in 2008, 2010, 2011 and 2012, plus tougher mortgage-lending standards introduced last year, have so far produced only temporary lapses in the housing frenzy. Home sales and prices are now on the rise again, particularly in frothy markets such as Toronto and Vancouver.
This isn’t necessarily proof that rules alone don’t work. Perhaps Canada should tighten further. Perhaps what we need is a hard-nosed review of government-backed mortgage insurance and the role of Canada’s Mortgage and Housing Corporation. The question, though, is whether bank regulators will have the guts to face the backlash that would come from adopting regulation powerful enough to work.
And that, indeed, is a question that weighs on the Fed as well.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.