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Integrating Monetary Policy and Financial Stability: A New Framework

Warapong Wongwachara, Bovonvich Jindarak, Nuwat Nookhwun, Sophon Tunyavetchakit and Chutipha Klungjaturavet
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Warapong Wongwachara: Bank of Thailand
Bovonvich Jindarak: Bank of Thailand
Nuwat Nookhwun: Bank of Thailand
Sophon Tunyavetchakit: Bank of Thailand
Chutipha Klungjaturavet: Bank of Thailand

PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research

Abstract: Since the aftermath of the Global Financial Crisis during 2007-2008, financial stability (FS) has become top priority for central banks around the world. The conduct of monetary policy (MP) sees no exception. By leveraging on the existing literature, we propose a systematic approach to incorporate FS considerations into MP framework. This starts with calculating a financial cycle (FC) which is a measure of financial imbalances and a predictor of financial crises. We then look at an FS dashboard which consolidates pockets of risks facing the financial sector, and show how it may be used in FS surveillance. Next, we discuss the concept of model development and introduce an example of a model platform to facilitate MP formulation. Nevertheless, when implementing MP to address FS risks, policymakers encounter an inter-temporal trade-off between financial and price stability. A key challenge towards MP decision-making is, therefore, to strike a balance between both mandates by designing the appropriate policy mix between monetary and macroprudential policies. As a demonstration of our approach, we discuss, in each section, an on-going attempt at the Bank of Thailand to systematically incorporate FS into flexible inflation targeting.

Keywords: Monetary Policy Framework; Financial Stability; Policy Trade-off (search for similar items in EconPapers)
JEL-codes: E52 G01 C54 (search for similar items in EconPapers)
Date: 2018-12, Revised 2018-12
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