Central banks should consider the growth of credit, not just inflation, when figuring out the right level of interest rates, according to a paper presented at the closely-watched Federal Reserve summit.
The study, led by Northwestern University economist Lawrence Christiano, found that stock market booms are, counterintuitively, accompanied by quite weak inflation.
So if policymakers were to rely on conventional models, which focus primarily on inflation expectations, they might cut interest rates and unduly boost excess optimism about share prices.
"A monetary policy which implements inflation forecast targeting using an interest rate rule would actually destabilize asset markets," the authors argue.
"The lower-than-average inflation of the boom would induce a fall in the interest rate and thus amplify the rise in stock prices."
The paper suggests that those who criticized the Fed for fueling the global financial crisis by keeping rates too low for too long may have a point.
Of course, the Fed's current predicament is quite different.
Officials gathered at Jackson Hole, Wyoming, for the central bank's annual retreat will be debating the prospect that a weakening U.S. recovery might require further monetary easing, at a time when official interest rates are already effectively at zero.
But the paper's findings are relevant to an ongoing debate about whether the Fed can and should attempt to lean against asset bubbles by raising interest rates when prices in specific markets look to be getting ahead of themselves.
The authors stopped short of advocating such an approach, but they do suggest that central bankers need to be more mindful of lending patterns than they have been in the past.
"If credit growth is added to the interest rate targeting rules, the resulting rule will tend to smooth out stock market fluctuations," the authors say.
The Federal Reserve has begun taking the first steps to crack down on debit-card transaction fees, with the battle between merchants and banks moving from the legislative to the regulatory arena.
The banks lobbied in vain against an amendment included in the financial reform act passed in July that limits some of their transaction fees.
Banks and analysts say billions of dollars in potentially lost revenue is at stake.
Banks are now trying to salvage what they can during the rulemaking process by trying to convince the Fed that some processing fees, like fraud prevention costs, should be broadly defined.
The Fed is preparing a survey that will likely be sent out in September to card issuers and card networks to collect the information that will be used in writing the regulations. The regulator has been having conference calls in recent weeks with banking and merchant groups while separately reaching out to consumer advocates.
The Fed declined to comment for this story.
The Dodd-Frank Act calls for new limits on so-called interchange transaction fees that banks receive from merchants, via card networks like Visa Inc and MasterCard Inc, when a customer uses a debit card.
The National Retail Federation estimates debit card fees, which are about 1 percent to 2 percent of each transaction, total $20 billion annually.
Bank of America spooked investors earlier this year by saying the processing fee limits could cost it between $1.8 billion to $2.3 billion annually, although analysts said that estimate is high.
The survey is expected to go out in September, with an eye toward a formal proposal later in the fall, and a final regulation in place by the law's mandated April deadline.
While the process will take months it is moving quickly by Washington's sometimes glacial rulemaking standards.
"Often the Fed lets rules simmer a long time if they don't get a timeline from Congress," said Ed Mierzwinski of the consumer group U.S. Public Interest Research Group.
The Fed is required to establish standards to determine whether the fees being charged by card issuers are "reasonable and proportional" to what it costs them to process the transaction.
Among the top concerns for banking groups is how fraud prevention costs will be factored into fee limits and what type of impact the rules may have on smaller institutions.
The law allows fraud costs to be considered as part of a transaction's cost and banking groups argue it should not be limited to just direct losses, but include protecting customer data and investigating claims. They want that information collected in the survey.
"Our big concern, at least initially, is that all the costs of fraud are captured," said Nessa Feddis, a vice president at the lobbying group the American Bankers Association. "That is clearly the intent of the legislation."
But some merchant representatives on the conference calls have questioned whether data protection costs should be included in the survey.
A representative for the National Retail Federation, a lobbying group for U.S. retailers, declined to comment directly on the Fed talks but said card issuers should shoulder fraud costs.
"If they can eliminate fraud, then they've eliminated the expense," NRF spokesman J. Craig Shearman said.
Consumer groups are concerned banks will inflate how much they actually spend on fraud prevention U.S. PIRG's Mierzwinski said. These groups have joined with retailers in arguing against the fees that are ultimately passed on to consumers.
The attempts to blunt the impact of the new debit fee limits comes as issuers cope with prior legislative crackdowns on credit cards that have resulted in reduced fee revenues and higher interest rates for consumers.
Smaller financial institutions are also following the Fed's deliberations even though the law specifically exempts those with less than $10 billion in assets from the new regime.
The groups representing credit unions and community banks say their members will likely be impacted and are pushing the Fed to seek their input when conducting the survey.
Cary Whaley of the Independent Community Bankers of America said the law fails to clarify how small banks will be exempted. They fear that while the Fed will set the fee limits based on debit card transactions' costs to large banks, there is nothing to stop merchants from applying that same rate to smaller institutions for which the transactions are more costly.
"If you are measuring the industry, you really should measure the entire industry to get a feel for what the pricing curve is," Whaley said.
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