Monetary Policy and Financial Stability

Policy Papers, August 28, 2015

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Monetary Policy and Financial Stability

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Bibliographic details

• Published: August 28, 2015
• Series: Policy Papers

Overview

• The issue of using monetary policy for financial stability purposes is described as "hotly contested."
• The crisis highlighted that price stability is not sufficient for financial stability, financial crises are costly, and policy should aim to decrease the likelihood of crises, not only rely on dealing with their repercussions once they occur.
• The text states that well-targeted prudential policies (including micro and macroprudential regulation and supervision) should be pursued actively to attenuate the buildup of financial risks.
• The core question posed: Should monetary policy be altered to contain financial stability risks, for example by temporarily raising interest rates more than warranted by price and output stability objectives, or by keeping rates persistently higher (noted as "also possible, but more costly")?

Key findings and themes

• Monetary policy vs. financial stability:
  • Price stability alone is insufficient to ensure financial stability.
  • Reducing the likelihood of crises should be an objective, not only managing their aftermath.
• Role of prudential policy:
  • Well-targeted microprudential and macroprudential regulation and supervision are emphasized as primary tools to attenuate financial risk buildup.
• Trade-offs in monetary policy adjustment:
  • Two monetary policy responses are considered:
  • Temporarily raising interest rates more than warranted by price and output stability objectives.
  • Keeping interest rates persistently higher, with the text noting this is "also possible, but more costly."

Policy considerations and questions for authorities

• Use prudential policies actively to address financial risk buildup (microprudential and macroprudential tools).
• Evaluate whether monetary policy should be adjusted to address financial stability risks, weighing:
  • The potential benefit of temporarily higher interest rates relative to price and output objectives.
  • The higher cost of keeping interest rates persistently above levels indicated by price and output stability.

Content in this bundle

• Monetary Policy and Financial Stability; IMF Policy Paper, August 28, 2015
  • Monetary Policy and Financial Stability; IMF Policy Paper, August 28, 2015 (Markdown version)
  • Monetary Policy and Financial Stability; IMF Policy Paper, August 28, 2015 (PDF)