In such an environment, the use of monetary policy is not the right instrument to address financial imbalances, and may lead to substantial deviations of aggregate output and inflation from their desirable levels. This is particularly so in a currency union where monetary policy affects the entire region, but financial imbalances may be local in nature.
Macroprudential policies, targeted at particular markets or countries, can play a key role in addressing such imbalances. Indeed, the ESRB last year identified medium-term vulnerabilities in some countries’ residential real estate sectors – precisely the type of situation that macroprudential policies are designed to address.