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.