Monetary Policy as Financial-Stability Regulation

51 Pages Posted: 9 Mar 2011

See all articles by Jeremy C. Stein

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 8, 2011

Abstract

This paper 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, 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.

Keywords: monetary policy, financial regulation

JEL Classification: G01, E58

Suggested Citation

Stein, Jeremy C., Monetary Policy as Financial-Stability Regulation (March 8, 2011). Available at SSRN: https://ssrn.com/abstract=1781306 or http://dx.doi.org/10.2139/ssrn.1781306

Jeremy C. Stein (Contact Author)

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