On May 4, 2016, Executive Vice President of the US Federal Reserve Bank of New York Simon Potter discussed steps the US Board of Governors of the Federal Reserve System has taken to improve the US monetary policy framework following the financial crisis in line with its principles of returning to normalization. He discussed the importance of creating a framework that can provide liquidity for monetary policy implementation and transmission. However, Potter noted that there are important tradeoffs to consider, in that financial market participants may anticipate that central banks, like the Federal Reserve, will make liquidity abundant during times of stress and manage their own liquidity conservatively. He suggested that the Basel III liquidity regulations, namely the liquidity coverage ratio which the US has adopted and the net stable funding ratio which the Federal Reserve has recently proposed, help to mitigate the risk that banks would rely too much on the central bank for liquidity. Potter also noted the importance of the US monetary policy framework being transparent in order to enable market participants to make better-informed decisions. Specifically, drawing parallels to the financial crisis, he observed that a central bank can help foster the contribution of liquidity to the financial system by market participants by committing itself to maintain liquidity.
Potter’s speech is available at: https://www.newyorkfed.org/newsevents/speeches/2016/pot160504