Reassessing the Regulatory Role of the Fed: Grappling with the Dual Mandate and More?

Reassessing the Regulatory Role of the Fed: Grappling with the Dual Mandate and More?

Many observers have proposed new regulatory content, specifically macro prudential regulatory powers, which would vary prudential standards over time to rein in financial system risks before they become too inflated.  Others have pointed to problems in the existing structure of regulation, especially the need to divest the Fed of its day-to-day authority over regulation and supervision.

The Fed should be removed from the day-to-day micro supervision and regulation to avoid its politicization, which threatens the independence of monetary policy and the effectiveness of regulation. The macro prudential regulator (whether the Federal Reserve (Fed) or a council of regulators) should develop a formal modeling framework for measuring systemic financial risk, which it would defend publicly. That model would describe how time-varying financial risk is measured, and how moments of high risk are identified. The framework would delineate how minimum capital requirements, provisioning requirements, and reserve requirements would respond to significant perceived increases in system-wide risk. The existence of such a framework would help make macro prudential regulation credible.

Monetary policy should also be rules-based. The Fed should formally adopt as a benchmark some specific inflation target and a Taylor Rule associated with that target. If the Fed were charged with both monetary policy and macro prudential regulation, it would be unnecessary and counterproductive for it to use the fed funds rate as a tool to deal with systemic financial risk, as doing so would weaken the accountability of both monetary policy and macro prudential policy; macro prudential policy should be implemented through time-varying minimum capital and liquidity standards for banks.

Higher prudential regulatory standards should be imposed on larger, more complex financial institutions. Those standards should be set by the micro prudential regulator (not the Fed) on the basis of clear formulae and should reflect the fact that complexity is a continuum. The rules governing the resolution of large failed financial institutions should be reformed to make it easier for large institutions to fail, and thus prevent abuse associated with too-big-to-fail bailouts and the moral-hazard problems they engender. It is inappropriate to create a new discretionary resolution authority over nonbank financial institutions that would be placed in the hands of the Fed or any other regulatory agency. Doing so would encourage rather than avoid too-big-to-fail bailouts.

The proper approach to reforming resolution policy for large banks and nonbank financial institutions has two parts: (1) reform of the U.S. bankruptcy code to make it more effective in managing nonbank financial institutions' failures, and more credible in imposing losses on stockholders and long-term debtholders of failed financial institutions, and (2) the establishment of legally binding agreements among regulators - starting with an agreement between the U.S. and the U.K. - that would clarify cross-border claims on failed institutions' assets by subsidiaries located in different countries.

Pew is no longer active in this line of work, but for more information, visit the main Pew Financial Reform page.

Spotlight on Mental Health

Composite image of modern city network communication concept

Learn the Basics of Broadband from Our Limited Series

Sign up for our four-week email course on Broadband Basics

Quick View

How does broadband internet reach our homes, phones, and tablets? What kind of infrastructure connects us all together? What are the major barriers to broadband access for American communities?

Pills illustration
Pills illustration

What Is Antibiotic Resistance—and How Can We Fight It?

Sign up for our four-week email series The Race Against Resistance.

Quick View

Antibiotic-resistant bacteria, also known as “superbugs,” are a major threat to modern medicine. But how does resistance work, and what can we do to slow the spread? Read personal stories, expert accounts, and more for the answers to those questions in our four-week email series: Slowing Superbugs.

Explore Pew’s new and improved
Fiscal 50 interactive

Your state's stats are more accessible than ever with our new and improved Fiscal 50 interactive:

  • Maps, trends, and customizable charts
  • 50-state rankings
  • Analysis of what it all means
  • Shareable graphics and downloadable data
  • Proven fiscal policy strategies


Welcome to the new Fiscal 50

Key changes include:

  • State pages that help you keep track of trends in your home state and provide national and regional context.
  • Interactive indicator pages with highly customizable and shareable data visualizations.
  • A Budget Threads feature that offers Pew’s read on the latest state fiscal news.

Learn more about the new and improved Fiscal 50.