July 20, 2017

July 20, 2017 Dear Senator, We are writing to express concerns about the monetary policy views of Randal Quarles, nominee for Federal Reserve Vice Chair for Supervision. As Vice Chair for Supervision, Quarles would serve as the Fed’s chief regulator. As a member of the Federal Reserve Board of Governors, Quarles would also vote every six weeks on monetary policy decisions made by the Federal Open Market Committee. Quarles’ expressed views about regulatory policy and the appropriate level of interest rates give us pause about his ability to perform either role in a manner that will protect the economy and serve the interests of working families. In a 2016 op-ed for the Wall Street Journal, Quarles warned against proposals that would limit the size of major financial institutions, and he seemed to suggest that raising interests rather than continuing rigorous macroprudential supervision was his preferred method for reducing systemic risk. Quarles wrote: “Years of near-zero interest rates have led to a rise in speculative positions across a wide range of asset classes, as all financial institutions find themselves under intense pressure to seek adequate returns.”1 In the same op-ed, Quarles recommended that the Fed “normalize interest rates and reduce the incentive for big banks and even smaller institutions to take dangerous risks.” Quarles concluded with a dire warning against enacting “Too Big To Fail” measures, writing that the Fed must “fully measure and evaluate the impact of Dodd-Frank on the financial system before arbitrarily taking an ax to big banks and irreparably damaging the economy.” Though Quarles’ concerns about asset bubbles and systemic risk are warranted, his formulation about what to do about it is exactly backward. The Fed has an array of regulatory tools at its disposal that can precisely target sources of risk and manage asset bubbles without doing broader damage to the economy. For example, the Fed announced in early 2016 that it was considering strengthening margin requirements, a tool the Fed used for many decades to rein in speculation by limiting the amount of debt that can be purchased with stock.2 While serving as a Treasury official earlier in his career, Quarles dismissed the notion that regulators should take such action against speculation and risk, saying, “Markets are always ahead of the regulators, and frankly that's how it should be. It's analogous to the advice that my father provided me that ‘if you don't miss at least two or three planes a year, you're spending too much time in airports.’"3 Quarles’ cavalier and simplistic attitude toward regulation raises serious questions about whether he should be entrusted with the top regulatory job at the nation’s foremost economic policymaking institution. Rather than simply accepting that regulators will miss problem spots, the Fed should use its regulatory powers to precisely measure and 1 “Focusing on Bank Size, Missing the Real Problem,” Wall Street Journal, March 2016, https://www.wsj.com/articles/focusing- on-bank-size-missing-the-real-problem-1459466136 2 “Fed Eyes Margin Rules to Bolster Oversight,” Wall Street Journal, January 2016 https://www.wsj.com/articles/fed-eyes- margin-rules-to-bolster-oversight-1452471174 3 Remarks By United States Treasury Assistant Secretary Quarles Harvard Symposium on Building the Financial System of the 21st Century: An Agenda for Europe and the United States Eltville, Germany, August 2005, https://www.treasury.gov/press- center/press-releases/Pages/js2463.aspx 1 respond to asset bubbles and economic risks. For instance, economist Thomas Palley has suggested that the Fed adopt asset- based reserve requirements, which would allow the Fed to target various sectors, like housing or energy markets, and rein in bubbles when they emerge.4 In contrast with these very precise available tools, monetary policy is the Fed’s most blunt tool for managing risk, akin to the ax that Quarles warns about. To truly tamp down on financial sector excess and speculation, the Fed would have to raise interest rates quickly, perhaps by several hundred basis points. Steep, quick interest rate hikes can and have caused lasting damage to the overall economy. Regulatory tools can be used more effectively, and unlike high interest rates, they don’t risk sapping aggregate demand, hurting consumers’ pocketbooks, and sending the economy into a recession. The Fed Up coalition has been a strong advocate for greater Fed public accountability, and in particular, the Fed’s monetary policy strategy needs to become much more clear. Nonetheless, we are deeply concerned about Quarles’ position—as stated in his 2016 op-ed—that the Fed should adopt the “Taylor Rule” as its monetary policy benchmark. One crucial defect of that rule is that it simply assumes that the “neutral” real interest rate—consistent with stable economic growth and stable inflation—is constant over time. Consequently, the Taylor Rule can lead to very large policy errors, especially at times when the neutral real interest rate is shifting significantly. Indeed, extensive research indicates that the neutral real interest rate in the United States (and likely globally as well) has declined markedly in recent years (see Laubach and Williams (2015), for example).5 The Taylor Rule also focuses exclusively on the conventional unemployment rate and ignores other indicators of labor market slack, such as involuntary part-time employment and labor force participation of prime-age adults. A recent analysis by economists Carola Binder and Alex Rodrigue found that requiring the Fed to follow the Taylor Rule “would likely be detrimental to the full employment goal.”6 Another recent study by economists at the Federal Reserve Bank of Minneapolis reached similar conclusions about the pitfalls of the Taylor Rule; that study estimated that 2.5 million fewer Americans would be working today if the Fed had adhered strictly to the Taylor Rule over the past five years.7 The working and low-income families that comprise the Fed Up coalition are struggling to attain the jobs and wages they need as is. It is difficult to imagine how they would have dealt with an even slower economic recovery from the Great Recession. In his confirmation hearing, we urge you to probe Quarles’ monetary and regulatory policy views. Quarles must be asked whether he truly believes that the blunt, job-killing tool of raising interest rates is the best means of reining in financial excess. Quarles should also be asked why he supports the Taylor Rule even though it would have crippled the Fed’s discretion to facilitate economic recovery. Because he favors monetary policy that would constrain the Fed’s ability to achieve its maximum employment mandate, we urge you to oppose Quarles’ confirmation. Thank you for your consideration. For more information, please contact Fed Up Campaign Manager Jordan Haedtler at [email protected] Sincerely, The Center for Popular Democracy NAACP Action NC PolicyLink Allied Progress Safe Places for the Advancement of Community and Equity (SPACEs) CASA Strong Economy for All Coalition Economic Policy Institute Texas Organizing Project Hoosier Action Working Families Party Make the Road New York New York Communities for Change 4 “Asset-based Reserve Requirements: Reasserting Domestic Monetary Control in an Era of Financial Innovation and Instability,” Thomas Palley, January 2004, 5 “Measuring the Natural Rate of Interest Redux,” Thomas Laubach and John Williams, October 2015, http://www.frbsf.org/economic-research/files/wp2015-16.pdf 6 “Monetary Rules and Targets: Finding the Best Path to Full Employment,” Center for Budget and Policy Priorities, Carola Binder and Alex Rodrigue, September 2016, http://www.cbpp.org/research/full-employment/monetary-rules-and-targets-finding-the- best-path-to-full-employment 7 “Taylor rule would have kept millions out of work,” Neel Kashkari, January 2017, Minneapolis Federal Reserve Bank, https://www.minneapolisfed.org/news-and-events/messages/taylor-rule-would-have-kept-millions-out-of-work 2 .

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