Dual mandate could threaten credibility Symposium on Financial Stability and the Role of Central Banks

According to Bundesbank President Jens Weidmann, monetary policy is not a suitable instrument for safeguarding financial stability. "When it comes to handling financial stability risks, monetary policy is a sledgehammer rather than a scalpel", he said at a speech delivered at the opening of a Bundesbank Symposium on Financial Stability and the Role of Central Banks. "The latter should be the preferred choice of tool, and getting it ready for use has to be a political top priority", he added.

Monetary policy needed to counter financial imbalances inasmuch as they endanger price stability, Weidmann said. However, he warned against adopting financial stability as an additional monetary policy objective on a par with price stability, underlining that this would overstate the accuracy and the effectiveness with which monetary policy could contribute to financial stability. Ultimately, central banks risked harming their credibility.

An end to "benign neglect"

Following the Bundesbank President’s welcoming remarks, economists Franklin Allen, Claudio Borio and Markus Brunnermeier, in a series of lectures, expounded on various aspects of the interaction between monetary policy and financial stability and discussed their findings with Volker Wieland (University of Frankfurt). Their papers revolved around the question of whether the "benign neglect" of financial stability by monetary policy could have reached its end.

In his speech, Franklin Allen (Wharton School at the University of Pennsylvania) showed how, through various channels, monetary policy can affect risks to financial stability. He noted that, in particular, real estate prices remain a longer-term threat in the current ultra-low interest rate environment. By contrast, Allen sees the greatest short-term risk to financial stability in rising interest rates, as these would affect financial stability directly through asset prices and also indirectly through debt sustainability and creditworthiness.

Claudio Borio (Bank for International Settlements) explained that crises are inseparable from "financial cycles" – alternating periods of financial boom and bust. He held that these cycles are too powerful for monetary policy alone to handle – fiscal policy is needed too, in his opinion. Monetary policy should lean more deliberately against booms and not ease too aggressively in busts. This more "symmetric policy" is, according to Borio, the key to doing more for financial stability. He does not believe that any changes to current central bank mandates are required.

Markus Brunnermeier (Princeton University) presented various crisis prevention and crisis management measures designed to protect financial stability. He regards the build-up of excessive short-term credit financing in individual sectors as the key indicator for prevention. During a crisis, wealth would have to be redistributed in order to recapitalise impaired sectors. He discussed various ways in which this could be accomplished.

Does monetary policy have a financial stability mandate?

At the symposium’s first panel discussion, moderated by Mark Schieritz, a correspondent at the German Die Zeit weekly newspaper, Viral Acharya, Olivier Blanchard, Richard Fisher, Otmar Issing and Klaas Knot then discussed whether central banks needed to play a more proactive role in safeguarding financial stability after the crisis and what problems that could involve. They also addressed Bundesbank President Weidmann’s sceptical comments on a dual mandate for central banks.

Viral Acharya (New York University Stern School of Business) is in favour of a broader mandate. In his opinion, if central banks looked out for financial stability when times are good, monetary policy would not have to intervene as a lender of last resort. This would liberate them from questions about their independence and responsibility after the event.

Klaas Knot (De Nederlandsche Bank), too, came out in favour of central banks taking responsibility. He sees central banks as being well positioned to take on such a broader role and does not think that their mandates need to be thoroughly rewritten but simply implemented and interpreted slightly differently. Knot also regards effective macroprudential policy as being one possibility of keeping central banks from having to stretch their monetary policy mandate to the limit. He admitted, however, that the effectiveness of macroprudential instruments still needed to be put to the test.

Otmar Issing (Center for Financial Studies), meanwhile, voiced serious concerns. He said that applying macroprudential instruments would create drastic redistribution effects,  for which democratic legitimacy was required. Issing warned that central banks that entered this policy area would undermine their independence. This would erode their ability to ensure price stability and would ultimately not enhance welfare.

Richard Fisher, President of the Federal Reserve Bank of Dallas and representing, in his own words, the "Bundesbank of the United States", referred to indirect legitimacy. In the United States, elected officials  pass the legislation transferring enormous responsibility to the central bank. Fisher noted, however, that how they would be judged ultimately depended on their success. He explained that governments delegated responsibility to central banks because central banks take action and make decisions, and argued that failure would jeopardise their independence.

Olivier Blanchard (International Monetary Fund) devoted special attention to the macroprudential policy of the emerging markets’ central banks, particularly emphasising measures to manage capital flows. Such measures included not only standard monetary policy but also macroprudential instruments, capital controls and intervention on the foreign exchange markets. However, none of these instruments was by itself sufficient, in his view, and they therefore needed to be used in concert. Arguing that we are now living in a time in which the tasks to be accomplished are greater than simply moving interest rates, he called for the involvement of central banks.