Monetary Policy as Financial-Stability Regulation

Year Published 2002
Business unit: Special Projects
Resource type: Discussion papers
File type: PDF
Theme(s): Economic Development, Finance, Policy analysis

Description

Jeremy C. Stein published this article in May 2011. This paper develops a model that speaks to the goals and methods of financialstability policies. There are three main points. First, from a normative perspective, the model defines the fundamental market failure to be addressed, namely that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, it shows how in a simple economy where commercial banks are the only lenders, conventional monetary-policy tools such as open-market operations can be used to regulate this externality, while in more advanced economies it may be helpful to supplement monetary policy with other measures. Third, from a positive perspective, the model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust frictionlessly and there are other transactions media besides bank-created money that are outside the control of the central bank.

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