Financial Stability At The Nexus Of Monetary And Macroprudential Policies

The Eurosystem delivered a swift and massive response to the Covid-19 crisis as it sought to maintain favourable financing conditions for the whole economy. This response was aided by the resilience of the financial system, which was strengthened by reforms introduced in the aftermath of the 2008 financial crisis. It was similarly able to draw on an expanded range of flexible and innovative monetary policy instruments. But a prolonged accommodative monetary policy can lead to adverse effects for financial stability through reduced market discipline, excessive risk-taking encouraged by the moral hazard created during the resolution of past crises, and increased leverage among economic agents. To more effectively prevent the risks of financial instability and safeguard monetary policy transmission channels, we need to go beyond the principle of strictly separating monetary and macroprudential policies and instead adopt a principle of coordination. However, the macroprudential framework remains an essential line of defence and must also be strengthened in two critical areas: the European framework needs to be bolstered; and non-bank financial institutions need to be included in the framework. These reforms represent the new frontier that we must cross as we build on progress towards a safer financial system, within Europe and around the world.