The active use of macro-prudential policy will provide a new array of “ex ante” policy instruments which can lean against asset price bubbles and reduce the pro-cyclicality of the financial system. Should monetary policy also be used to “lean” against asset price bubbles and building imbalances?
The importance of monetary policy for financial bubbles and imbalances has been underscored by growing empirical evidence10 that holding interest rates too low for too long is likely to lead to declining lending standards and growing risk-taking in the banking system. This is associated with significantly higher defaults over time.