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For immediate release: April 21, 2010

Addressing Too-Big-to-Fail and Retaining Fed’s Regulatory Duties Key to Effective Monetary Policy, Says Dallas Fed

DALLAS— Stripping the Federal Reserve of regulatory functions would compromise the ability of the Fed to conduct effective monetary policy, according to the latest issue of the Federal Reserve Bank of Dallas’ Economic Letter.

In “Regulatory and Monetary Policies Meet ‘Too Big To Fail,’” Harvey Rosenblum, Jessica Renier and Richard Alm assert real-time data on the health of the financial system and the institutions within it are necessary for a number of key central bank decisions, such as the timing, strength and tactics of monetary policy actions, including lender-of-last-resort policies and decisions.

“Monetary and regulatory policies are inseparable,” they write. “Its supervisory role puts the Fed’s finger directly on the pulse of the financial system, providing a tool that serves the goal of effective policymaking.”

The article also serves as a review of how both monetary and regulatory policies intersect with too-big-to-fail (TBTF).

Prompt corrective action (PCA), regulatory initiatives mandated by legislation after the savings and loan crisis of the 1980s, are ineffective in the era of complex, TBTF banks, according to the authors.

“For supervisory agencies, this overwhelming complexity makes determining the condition of such banks an epic undertaking in time and manpower—an obstacle to the ‘prompt’ in PCA,” the authors state.

Moreover, the regulatory issues surrounding TBTF banks help explain why it took so much monetary policy firepower to deal with the financial crisis.

Rosenblum is executive vice president and director of research at the Federal Reserve Bank of Dallas. Renier is senior economic analyst and coordinator of economic and financial analysis in the Bank’s research department. Alm is writer in residence at Southern Methodist University’s O’Neil Center for Global Markets and Freedom.


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James Hoard
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