While a strong economy can improve the resilience of the financial system, it can also lead to overconfidence and greater risk-taking, increasing overall vulnerability, the chairman of the U.S. central bank board said Wednesday.
However, he quickly added that U.S. financial system vulnerabilities are moderate.
Speaking at the European Central Bank (ECB) Forum on Central Banking in Sintra, Portugal, Federal Reserve Board Chairman Jerome “Jay” Powell agreed that strong economic conditions can make the financial system better able to absorb shocks through strong balance sheets and investor confidence.
“But we have often seen confidence become overconfidence and lead to excessive borrowing and risk-taking, leaving the financial system more vulnerable,” Powell told the conference organized by the ECB, which is the central bank of the 19 European Union countries which have adopted the euro.
“Indeed, the fact that the two most recent U.S. recessions stemmed principally from financial imbalances, not high inflation, highlights the importance of closely monitoring financial conditions,” Powell added.
The Fed chairman noted, however, that he views U.S. financial stability vulnerabilities “as moderate and broadly in line with their long-run averages.”
“While some asset prices are high by historical standards, I do not see broad signs of excessive borrowing or leverage,” he said. In addition, Powell said, banks have far greater levels of capital and liquidity than before the financial crisis of the late 2000s.
With regard to the economy and interest rates in general, the U.S. central bank leader said that – with a strong economy and “risks to the outlook balanced” – the case for continued, gradual increases in interest rates “remains strong and broadly supported” by Fed policymakers.