Needed but rejected: How to implement the financial stability objective into monetary policy?

Abstract

The 2008 crisis forced central bankers and the representatives of academic literature to reassess the prevailing consensus on practice of monetary policy. Among other topics, the spotlight also fell on the question that how financial stability must be treated. Debate renewed on whether the central bank must play an active role in preventing and managing market turmoil, which consists of leaning against the wind of markets. This paper summarises opinions on this issue and offers our own conclusions. We found that currently neither the theoretical background nor empirical experience provide compelling evidence or a reference for central bankers to move away from their existing monetary policy framework and adopt a leaning against the wind policy. We conclude that the direct integration of financial stability considerations into monetary policy decision-making - i.e. as a form of rules - is not expected in the near future. However, we think that the debate remains open for two reasons: firstly, there is some uncertainty regarding the success of macroprudential regulation and its proper cooperation with monetary policy and secondly, the theoretical development of the implementation of financial cycles into monetary decision-making may also yield results.