Monetary Policy, Financial Conditions, and Financial Stability

45 Pages Posted: 18 Jul 2016

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Nellie Liang

Brookings Institution

Multiple version iconThere are 2 versions of this paper

Date Written: July 2016

Abstract

We review a growing literature that incorporates endogenous risk premiums and risk taking in the conduct of monetary policy. Accommodative policy can create an inter-temporal tradeoff between improving current financial conditions at a cost of increasing future financial vulnerabilities. In the U.S., structural and cyclical macroprudential tools to reduce vulnerabilities at banks are being implemented, but may not be sufficient because activities can migrate and there are limited tools for nonbank intermediaries or for borrowers. While monetary policy itself can influence vulnerabilities, its efficacy as a tool will depend on the costs of tighter policy on activity and inflation. We highlight how adding a risk-taking channel to traditional transmission channels could significantly alter a cost-benefit calculation for using monetary policy, and that considering risks to financial stability as downside risks to employment - is consistent with the dual mandate.

Keywords: financial conditions, financial stability, leaning against the wind, macroprudential policy, monetary policy rules, monetary policy transmission, risk taking channel of monetary policy

Suggested Citation

Adrian, Tobias and Liang, Nellie, Monetary Policy, Financial Conditions, and Financial Stability (July 2016). CEPR Discussion Paper No. DP11394, Available at SSRN: https://ssrn.com/abstract=2811090

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://www.tobiasadrian.com

Nellie Liang

Brookings Institution

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

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