IMF: Make central banks responsible for financial stability

Feb 4 (Reuters) – Financial stability should become a core central banking objective alongside monetary policy, although potential conflicts between the two functions might require some institutional re-design, the IMF said on Monday.

The International Monetary Fund in a study noted that although central banks had delivered low inflation, they had failed to prevent the devastating global financial crisis of 2008-2009.

As a result, the IMF said new tools were needed to prevent excessive risk-taking, and it said central banks may be best-placed to take on these tasks, although monetary policy should stay primarily focused on price and output stability.

“The interaction between monetary and macroprudential policies has implications for institutional design. Policy coordination can improve outcomes, making it advantageous to assign both policies to the central bank,” the IMF wrote.

The crisis sparked a push for widespread financial reform, led by the Group of 20 of advanced and emerging economies.

But harnessing monetary policy to the goal of financial stability is controversial in central banking circles, where the consensus that policymakers should concentrate on inflation and growth has been strained by the lessons of the crisis.

The U.S. Federal Reserve’s vice chair, Janet Yellen, in a speech early last month, said financial stability was essential to sustained economic growth and prosperity. That connection is implied by the U.S. central bank’s dual mandate of supporting full employment along with low and stable prices.

Other Fed officials have questioned whether monetary policy was the right tool to safeguard financial stability.

The IMF agreed there may be side-effects from using monetary policy for macroprudential goals, and policies face many constraints. But it said that the existence of macroprudential policies could enhance monetary policy credibility.

“Well-calibrated and clearly communicated macroprudential policies can contain risks … and help buffer shocks, and thereby ease the conduct of monetary policy during periods of financial stress,” the study said.