Seperation of monetary and financial stability issues

Economist’s View links to a post on the Vox EU site by Hans Gersbach.  At the start of the post Mark Thoma states:

I have argued many times that the Fed should have two roles. It should conduct monetary policy, and it should be the primary regulator of the financial system. However, not everyone agrees. When I was at the What’s Wrong with Modern Macro Conference in Munich recently, I met Hans Gersbach — we were on a panel together — and he passes along his argument that monetary policy and banking regulation should be conducted by separate bodies

So the disagreement here is not about the two instruments for central banks – in fact in the monetary policy community there is a strong degree of agreement regarding these two roles.  The disagreement stems from who should be in charge of the instruments – should we have one authority controlling both, or separate authorities.

This is a fascinating issue, and I have previously said I am on the side of SEPARATING.

My reasoning is that separating “monetary” and “financial stability” issues is essential in order to create transperancy in the public regarding policy movements.  If we can make sure that changes in the Bank’s cash rate are related to “monetary” policy and changes in prudential regulation/settings are related to “financial stability”.  By doing this, the actions/intentions of the individual institutions are more obvious and are more likely to anchor expectations – which is the point.

Of course monetary and financial stability policies, and these instruments (interest rates and prudential policy) are heavily related.  But of course, we know that monetary policy and fiscal policy is as well.  The fact is that in order to signal policy and control expectations we NEED individual instruments to be targeted at individual variables – and having separate institutions helps to clarify this fact.

  • Isn’t NZ too small to separate those roles?

    RBNZ did a pretty good job of doing both at once?

    cheers
    Bernard

  • @Bernard Hickey

    No. They do both separately under the same roof now – they just need to be more explicit about the difference between the two. Otherwise we get mixed signals.

    We don’t necessarily even need two separate institutions in a country as small as NZ – as long as we have clear and transparent operational separation. Of course, we don’t have that now – which is why we get talk of “financial stability” in monetary policy meetings …

  • This is a fascinating issue, and I have previously said I am on the side of SEPARATING.

  • Absolutely right and I’m on the side of separating the two as well.

    Beyond transparency, removing some of the ability for political gain over public benefit is the reason. When each is evaluated according to its own merits, game playing is reduced, and the public’s likelihood of being used as a pawn diminishes.

  • @how to learn chinese

    Yeah, it is a very interesting issue. Like you, I’m also on the side of separating. 🙂

  • Sam

    What about achieving financial stability by not messing around with monetary policy? In other words having a set amount of money that is backed by a real and finite commodity?

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