Inflation Targeting and
Financial Stability
Scott Roger, IMF
IMF - CAPTAC-DR
2-11 November 2010
Scott Roger
Overview and Issues
2007-2009 financial crisis has raised significant
concerns about monetary policy frameworks,
including IT:



Should financial stability be made an explicit
objective of monetary policy?
How can monetary policy take better account of
financial developments and vulnerabilities?
What should be the relationship between
monetary policy, macro-prudential, and microprudential policies?
All 3 issues are active areas of research and
debate.
IT and financial stability
Should financial stability be an explicit objective
of monetary policy? General consensus is no:
 Adding additional objective would compromise
commitment to price stability, weakening credibility.
 Macro-prudential policies are likely to be more efficient
in addressing financial vulnerabilities and imbalances.
 Monetary policy can still take financial stability
concerns into account, even if not an explicit objective
(like growth or exchange rate)
Taking financial stability into account in IT
Monetary policy needs to take better account of
financial developments and vulnerabilities.
First priorities:
 Need to strengthen understanding and modeling
of financial transmission and effects of prudential
measures
 Standard monetary policy models do not include
financial sectors and have very simplified
representation of financial transmission.
 Limited understanding of behavior of financial firms
and interactions between them.
Taking financial stability into account in IT
 Need to strengthen modeling and analysis of housing
market and business finance-production link.
 Need to strengthen monitoring of financial
developments and vulnerabilities, and bring
systematically into policy decision making and
communications.
Both areas are current priorities for central
banks and financial supervision agencies.
Taking financial stability into account in IT
Issue of how to factor financial stability into
monetary policy. Different views:
 Discretionary approach. Reflects difficulty in
defining financial stability, uncertain financial
transmission, need for flexibility in handling policy
trade-offs. Flexible, but not very transparent. May
also be biased toward no action.
 Lengthen policy horizon. This brings gradually
emerging financial imbalances into the relevant
policy horizon. More gradual response to inflation
developments also gives more room to respond to
financial imbalances or risks.
Taking financial stability into account in IT
 Rules-based approach. Reflects concern for policy
transparency, and accountability, as well as potential
policy inertia.
Approach adds financial stability indicator to policy
reaction function. Need to determine:
 Appropriate indicator, trend value, and whether level or
changes matter;
 Appropriate weight to place on indicator;
 Relevant policy horizon (use forecast, current, or
lagged indicator).
 Rule needs to be supplemented with discretion, and
reviewed as knowledge is gained.
Financial stability policies
Recognition that financial stability policies need to
have a more macro perspective:
 More systemic focus (not institution by institution)
 More attention to procyclicality (problem with Basel II)
Design of macroprudential “tools” still need to be
worked out as well as appropriate institutional
arrangements. But central bank will need to be
closely involved in both, and use of policies
taken into account in monetary policy.
Policy coordination and cooperation
Monetary and financial stability policies overlap
and are interdependent. Need for coordination
and cooperation. How?
 Need for information sharing arrangements among
financial supervisors to get overall picture;
 Need for decision-making process that includes all
relevant players, but that is accountable;
 Need decision making body that has an important
degree of autonomy from political and monetary
policy decision making.
Policy coordination and cooperation
Europe and US opting for financial stability
councils including central bank, but not part of
central bank. In other cases, body may well be in
the central bank (financial stability department?),
but location is less important than effectiveness.