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Former NY Fed President Bill Dudley on lending

Former NY Fed President Bill Dudley says Federal Reserve role has not changed this time it arrived as financial crisis started unlike in 2008. Financial system this time on bank side working well and Fed has provided support.

Video Transcript

BILL DUDLEY: I don't think it's changed in a particularly-- a big way. I mean, I think what's happened this time is the Fed arrived before the crisis actually got underway in terms of the financial sector. Last time, the Fed arrived sort of grudgingly as the financial crisis was well underway. I mean, the primary dealer credit facility in 2008 was enacted as Bear Stearns was actually failing.

The second thing I think is an important distinction is that the financial sector itself is in much better shape. I mean, the things that were done to require big banks, which now include most of the major securities dealers, to hold more liquidity, more capital. Stress testing of capital means that the people have confidence that the banking system is going to make it through this crisis period in reasonably good shape. Last time, it was the loss of trust in the banking system that contributed to the downturn in economic activity.

So I think the financial system this time is mostly working well, especially in the banking portion. The nonbank portion has shown a few signs of strain. But then the Federal Reserve is coming and basically providing support there through the backstop of market making facilities.

BRIAN CHEUNG: And you bring up a good point about financial stability. That's a huge part of the reaction function for the Fed now under its new framework, which it released at Jackson Hole virtually in August. So the idea here being that the Fed would tolerate inflation, moderately overshooting its 2% target, also prioritizing maximum employment.

But that's not unconditional that the Fed could still raise rates early if it felt like there were financial instability risks that were bubbling up in whatever market you want to look at. What do you see as that meeting? What could that look like if financial stability risk kind of ended up coming up, and then the Fed says, you know what? We need to lift off a little bit early.

BILL DUDLEY: I think the bar is pretty high to doing something like that because monetary policy just isn't a very good tool to try to tamp down financial excesses in particular markets. So the Fed could, in theory, design a tight monetary policy early because they're worried about markets becoming too exuberant. But I think the bar to doing that is actually-- would be quite high.

I think the Fed would be looking at other actions. You know, for example, the countercyclical [INAUDIBLE] buffer where they could raise capital requirements for banks, or more just jawboning the market and saying, look, this is an area where we think the markets are tested valuation.

The Fed, unlike 10 years ago, the Fed now publishes a semi-annual financial stability report. So it actually has a medium to communicate to people about how they see financial markets. Really, it is, though, in the United States, the Fed doesn't really have great tools to tamp down market excess.