On the Nexus of Monetary Policy and Financial Stability: Recent Developments and Research

Oleksiy Kryvtsov, Miguel Molico and Ben Tomlin

Discussion Papers from Bank of Canada

Abstract: Because financial and macroeconomic conditions are tightly interconnected, financial stability considerations are an important element of any monetary policy framework. Yet, the circumstances under which it would be appropriate for the Bank to use monetary policy to lean against financial risks need to be more fully specified (Côté 2014). The extent to which financial stability concerns should be taken into account by monetary policy will be a priority topic of research at the Bank for the renewal of the inflation-control target agreement in 2016. This paper reviews four considerations of interest, taking stock of key domestic and international developments and knowledge gained over the past few years: (i) Canada and other countries have made significant progress in the implementation of micro- and macroprudential regulatory reforms, and limited existing research finds that most of these policies were effective in reducing the potential need for leaning by monetary policy; (ii) the effectiveness of the monetary policy transmission mechanism depends on the state of the financial system, implying that financial system conditions need to be taken into account by monetary policy; (iii) although exceptionally low interest rates and other forms of monetary stimulus are sometimes needed to support growth and achieve inflation-target mandates, they may lead to excessive risk-taking activities and therefore contribute to the buildup of financial imbalances; and (iv) coordination of monetary and macroprudential policies for dealing with imbalances may, in some circumstances, be beneficial. The paper concludes by identifying future areas of research to further clarify the role of monetary policy in addressing financial stability risks.

Keywords: Financial stability; Monetary policy framework (search for similar items in EconPapers)
JEL-codes: E0 E44 E52 E58 G18 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2015
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocadp:15-7

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