Inflation Versus Central Bank Independence? Banking Regulation and Financial Stability in the U.S. And Germany
WZB Discussion Paper No. 1011-9523
54 Pages Posted: 24 Oct 2004
Date Written: November 1995
Most recent discussion of the relationship between the banking system and macroeconomic performance have focused on the degree of independence of the central bank as the key variable influencing the choice between inflation and unemployment. This paper argues that the stability of the financial system is a goal of central banks with at least as much priority as the other two goals, and that tight money policies implemented to achieve monetary stability may conflict with the goal of financial system stability; furthermore, the nature of regulation and underlying health of the financial system is a crucial factor influencing the extent of the monetary versus financial system stability tradeoff dilemma. The erosion of prudential regulation and increasing weakness of large segments of the financial system in the US, in large part due to arbitrage between competing regulatory authorities, has since the 1960s put the Federal Reserve Board in the dilemma of controlling inflation versus protecting financial system stability. The German Bundesbank in contrast has had a freer reign in monetary policy, since corporatist bank regulation including strict prudential standards and the prohibition of potential bank competitors has resulted in a stronger underlying financial structure.
Keywords: Financial systems, regulation, banking
JEL Classification: G2, G3
Suggested Citation: Suggested Citation