Financial strongstabilitystrong and monetary policy Frank Smets European.pdf

25 May 2013 Preliminary and incomplete Financial stability and monetary policy: 1 How closely interlinked? Frank Smets European Central Bank 1. Introduction The 2007-2008 financial crisis and its long-lasting legacy have shaken up the macro- economic policy framework that appeared to be so successful in stabilising the economy during the great moderation period. First, it led to a rethinking of monetary policy frameworks focused primarily on maintaining price stability, as price stability has proven not to be a sufficient condition for financial stability and lack of financial stability can have large negative feedback effects on price stability.2 Second, it accelerated the introduction of a new policy domain called macroprudential policy, inspired by the early contributions of Crockett (2000) and his colleagues at the Bank for International Settlements (BIS).3 This was based on the realisation that ensuring the soundness and safety of individual financial institutions is not enough to guarantee the stability of the whole financial system and that there is a need for a systemic approach to financial stability. 4 Third, specifically to EMU, the sovereign debt and banking crisis made the financial trilemma of having a single monetary policy, an integrated financial market and a national financial supervisory system painfully 1 This paper was prepared for the Riksbank Conference on “Two decades of inflation targeting: Main lessons and remaining challenges”, held in Stockholm on 3rd June 2013. The views expressed are my own and not neces