Monetary Policy, Financial Conditions, and Financial Stability

Tobias Adrian and Nellie Liang
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Nellie Liang: Brookings Institution

International Journal of Central Banking, 2018, vol. 14, issue 1, 73-131

Abstract: We review a growing literature that incorporates endogenous risk premiums and risk-taking in the conduct of monetary policy. Accommodative policy can create an intertemporal tradeoff between improving current financial conditions at a cost of increasing future financial vulnerabilities. In the United States, structural and cyclical macroprudential tools to reduce vulnerabilities at banks are being implemented, but may not be sufficient because activities can migrate and there are limited tools for non-bank intermediaries or for borrowers. While monetary policy itself can influence vulnerabilities, its efficacy as a tool will depend on the costs of tighter policy on activity and inflation. We highlight how adding a risk-taking channel to traditional transmission channels could significantly alter a cost-benefit calculation for using monetary policy, and that considering risks to financial stability—as downside risks to employment—is consistent with the dual mandate.

Date: 2018
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Related works:
Working Paper: Monetary Policy, Financial Conditions, and Financial Stability (2016)
Working Paper: Monetary policy, financial conditions, and financial stability (2014)
Working Paper: Monetary Policy, Financial Conditions, and Financial Stability (2014)
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