The Role of Monetary Policy in Matters Relating to Financial Stability: Monetary Policy Responses Adopted During the Most Recent Financial Crisis

Abstract

As well as providing an analysis of how financial stability could be sustained through the appropriate targeting of policy instruments at debt gearing, this paper aims to provide an overview of the respective roles which governments and shareholders could assume in deterring financial institutions from overly relying on certain policy measures (role of governments) and in reducing tax burdens on tax payers (role of shareholders). The duration of the recent Crisis has also witnessed the introduction of mechanisms aimed at bailing- in financial institutions – rather than merely bailing them out.

Even though monetary policy measures should ultimately be targeted at macro level, the respective roles assumed by governments and shareholders at micro level in facilitating the phasing out of certain monetary policy measures and assuming responsibility as the first resort during the impending collapse of a financial institution, are also of vital importance. This paper also aims to consider additional measures which could be implemented as a means of mitigating the number of financial institutions which could become overly dependent on monetary policy and liquidity sustenance measures provided during deteriorating financial conditions. Greater focus on strategies aimed at mitigating the number of financial institutions which could become overly dependent (bail-in strategies which could address bail outs) – rather than simply focusing on measures and exit strategies aimed at weaning such institutions after assistance has been granted to these financial institutions, could prove to be more effective.

A brief comparative analysis of the monetary policy response implemented in the Euro area during the recent Financial Crisis (against that which was implemented in the United States), will also be provided in this paper.

Keywords: monetary policy, central banks, financial crises, bail in, bail outs, liquidity, ECB, Federal Reserve, interest rates, regulation, stability, capital, Basel III