06 June 2014

BIS/Caruana: Redesigning the central bank for financial stability responsibilities

Jaime Caruana, General Manager of the Bank for International Settlements, argued that since much of the responsibility for financial stability policy is shared, integrating financial stability considerations into monetary policy, and vice versa, presents tough institutional challenges.

Whereas we had come to think of monetary and financial stability as two separate things, we are now realising how damaging it can be to keep them separate. This is for many a new realisation. And it is what I want to talk about today. The main points I want to make are the following:

• Price stability and financial stability are part of the same public good.
• A perfectly neat assignment of policy instruments - the short-term interest rate to monetary stability (via exchange rate stability or otherwise), prudential tools to financial stability - is not always feasible or sensible.
• Financial cycles, which feature a build-up of leverage and risk-taking on the upswing, last longer than the standard business cycle. Financial cycles interact strongly with the real economy and require a symmetric policy of leaning against it as well as cleaning up after it.
• Since much of the responsibility for financial stability is shared, integrating financial stability considerations into monetary policy, and vice versa, presents tough institutional challenges. Independence of action against the build-up of financial imbalances is as important as independence of action against the threat of inflation or deflation.

To summarise, I take heart from the cases of Hong Kong SAR, Malaysia, Singapore and Thailand, among others. These are examples of central banks in charge of both monetary and financial stability policies, within transparent regimes. They are alert to risks of financial instability and are willing to take pre-emptive measures even when dangers are not certain, having carefully considered the side effects. And they seem able to explain those measures to the public.

I take heart from the fact that so many parliaments have been seeking to fill the policy gaps revealed by global financial crisis, even where their countries were not directly involved.

I accept that this is difficult territory. Important powers of state are involved, with important consequences for citizens' lives should policy failures due to inaction or misdirected action occur. And I accept that dealing more effectively with financial stability concerns, and their intersection with prices stability ones, is going to be an evolutionary process.

Making progress will require a deeper understanding of the nature of financial instability, and its connections to monetary policy, such that we can set clearer objectives and make the reasons for action more transparent. And making progress will require the recognition that both price and financial stability are essential ingredients of the monetary systems of well functioning economies, and that they are in fact two aspects of the same public good.

Full speech

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