* Says regulation should be main tool to safeguard stability
* Yellen sees some areas of concern, cites leveraged loans
* Monetary policy should focus on price stability, jobs -
(Adds details and quotes from speech, question-and-answer
By Michael Flaherty and Howard Schneider
WASHINGTON, July 2 Monetary policy faces
"significant limitations" as a tool to counter financial
stability risks, Federal Reserve Chair Janet Yellen said on
Wednesday, adding that heading off the U.S. housing bubble with
higher interest rates would have caused major economic damage.
Weighing in on a global debate, Yellen reiterated her view
that regulation - not rate policy - needs to play the lead role
in combating excessive financial risk-taking.
"The potential cost ... is likely to be too great to give
financial stability risks a central role in monetary policy
discussions," Yellen said at an event sponsored by the
International Monetary Fund.
She didn't close the door entirely, however, and she cited
some areas that bore monitoring with an eye toward a possible
tightening of regulation.
Analysts said Yellen was pushing back against some Fed
officials who believe financial stability should be given a more
prominent place in formulating monetary policy.
Jeremy Stein, who stepped down as a Fed governor in May, had
sparked the debate by arguing higher rates should at least be
considered to help stamp out possible asset bubbles, and a
number of regional Fed bank presidents have warned of the
dangers of keeping rates near zero for too long.
But Yellen made clear she did not see a need for the U.S.
central bank to alter its current course. "I do not presently
see a need for monetary policy to deviate from a primary focus
on attaining price stability and maximum employment," she said.
The U.S. stock and bond markets have soared on the back of
the Fed's money-printing and near-zero rates, prompting warnings
from some economists that new bubbles are forming. The IMF said
last month a prolonged period of ultra-low U.S. rates - they
have been near zero since late-2008 - had prompted a weakening
in lending standards and risky behavior by investors.
For her part, Yellen pointed to unusually narrow corporate
bond spreads, a lack of financial volatility and weak lending
standards in the leveraged-loan market as areas of concern.
"It is critical for regulators to complete their efforts at
implementing a macroprudential approach to enhance resilience
within the financial system," she said.
Yellen said building a stronger system was all the more
important because economies around the globe could be in need of
historically low rates for some time to come, whether due to
scars from the financial crisis or deeper underlying economic
Because of that, central banks could run out of room to cut
rates more frequently when financial shocks hit, she warned.
Yellen cited a number of steps the United States had taken
to strengthen its financial sector, including setting higher
capital requirements for banks.
In making her case that regulation should be in the
forefront of fighting financial stability risks, she harkened
back to the mid-2000s, when U.S. housing prices were soaring.
Yellen argued a "very significant tightening" of monetary
policy would have been needed to stop the housing bubble from
building, and that the cost would have been a very large
increase in unemployment.
(Reporting by Michael Flaherty and Howard Schneider; Additional
reporting by Krista Hughes, Jonathan Spicer and Jason Lange;
Editing by Paul Simao)