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Monetary Policy as Financial Stability Regulation

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  • Jeremy C. Stein
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    Abstract

    This article develops a model that speaks to the goals and methods of financial stability 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, whereas 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. Copyright 2012, Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/qje/qjr054
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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

    Volume (Year): 127 (2012)
    Issue (Month): 1 ()
    Pages: 57-95

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    Handle: RePEc:oup:qjecon:v:127:y:2012:i:1:p:57-95

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