Monetary Policy and Financial Stability: Cross‐Country Evidence

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. iii Terms of use: Documents in EconStor may AbstractCentral banks may face challenges in achieving their price stability goals when financial stability risks are present. There is, however, considerable heterogeneity among central banks with respect to how they manage these potential trade-offs. In this paper, we review the institutional and operational policy frameworks of ten central banks in major advanced economies and then assess the effect of financial stability risks on their monetary policy decisions according to these frameworks. To do so, we construct a timevarying financial stability orientation (FSO) index that quantifies a central bank's policy orientation with respect to financial stability that spans the major viewpoints of the literature: "leaning against the wind" versus "cleaning up after the crash." The index encompasses three dimensions: (i) the nature of the statutory frameworks, (ii) the extent of the regulatory tool kit, and (iii) the prominence of financial stability references in central bank monetary policy statements. We then include our FSO index in a modified Taylor rule, which is estimated using a cross-country panel of up to ten central banks for the period from 2000Q1 to 2014Q4. We find that in episodes of high financial stability risks, measured by a strongly positive credit to GDP gap, "leaning-type" central banks, i.e., those with a high FSO index value, appear to account for financial stability considerations in their monetary policy rate decisions. For "cleaning-type" central banks, we do not find this to be the case. Our baseline specification suggests that a representative leaning-type central bank's policy rate is about 0.3 percentage points higher when financial stability risks are present than the policy rate of a representative cleaning-type central bank. We also find that the strength of this response increases in the additional presence of a house price boom but not so for the simultaneous occurrence of an equity price boom. JEL classification: E5, E4, G01 Bank classification: Monetary policy framework; Financial stability; International topicsRésumé L'atteinte des objectifs des banques centrales en matière de stabilité des prix peut présenter des défis lorsque des risques pèsent sur la stabilité financière. Les banques centrales gèrent toutefois très différemment les unes des autres les arbitrages potentiels qui découlent de ces deux pôles. Dans cette étude, nous examinons les cadres de politique institutionne...

Institutional mandates for macroeconomic and financial stability

“…subject to the first-order conditions of the private sector and the simple implementable rule (39), whereas the financial regulator sets the reserve coefficient requirement just as under the second mandate. This mandate is consistent with monetary policy "leaning against the wind," as documented in studies of the impact of financial stability risks on policy interest rates (see for instance Friedrich et al (2015)) and the idea of integrated inflation targeting discussed by Agénor and Pereira da Silva (2013). 18 To compare how the economy performs in terms of macroeconomic and financial stability under the three alternatives mandates, it is convenient to define the policy loss function,  , in terms of the unconditional variances of the macroeconomic and financial variables: 19…”

Evaluating the Impact of Financial Stability and Monetary Stability on Economic Growth: Evidence from an Emerging Economy

“…It appears that there is a favorable and considerable effect of financial development and monetary policy reforms on economic growth. (Friedrich, Hess, & Cunningham, 2019). Sadia, Bhatti, and Ahmad (2019) principal Component Analysis was used to develop the financial stress index and analyze Pakistan's economy for the period 1993M1-2016M12.…”

Monetary policy, prudential policy and bank's risk‐taking: A literature review

“…On the other side, some concerns are expressed as a counter-argument to the first point of view. Friedrich et al (2019) provide an overview of institutional set-up in some countries where prudential regulation is conducted solely by the central bank (New Zealand, England), jointly by the central bank and a supervisory authority (Switzerland, USA, Norway, European union), or solely by a supervisory authority (Australia, Canada, Japan, Swenden).…”