Those dynamics obviously have a direct impact on financial stability. Financial fragility comes out of excessive leverage and maturity transformation, fueling asset price increases. And, conversely, liquidity shocks and deleveraging are the symptoms and channels behind financial crises. As importantly, and less recognized until recently, those dynamics also have a major impact on the transmission mechanism of monetary policy. The functioning of the credit channel, but also the interest rate channel depend on financial intermediaries being able to fund themselves and arbitrage across different market segments, instruments and maturities. Dysfunctional credit markets were a major reason why Central Banks embarked into exceptional liquidity provision, credit easing and asset purchases. One important point, here, is that the same dynamics affect both financial stability, on the one hand, and monetary transmission channels, on the other. Now, presumably, any macro prudential policy would try and influence the evolution of maturity transformation and leverage. By doing so, however, it would also have a monetary impact. And, conversely, changing the monetary stance, by moving policy rates, also may have an influence on financial stability. The relative strength of those influences is not empirically known. Those of us who would use monetary policy with a financial stability objective implicitly assume that leverage and maturity transformation are very sensitive to interest rates. I am not sure this is true.
2  BIS central bankers’ speeches    Second, monetary policy is about setting interest rates, but also involves observing and analyzing leverage and liquidity. Monetary aggregates as well as the volume and modalities of maturity transformation reveal very useful information on the transmission mechanism. This is actually the conventional wisdom within the Eurosystem, through the use of the second pillar. Although less acceptable outside the euro area, I conjecture that the lessons of the crisis will trigger some rethinking here and there.   Finally, the debate on whether monetary policy should also aim at financial stability must give more consideration to the awkward interaction between instruments and the diversity of accountability regimes. Both create the potential for additional confusion about the ultimate objectives of each policy. It seems to me that most of the discussions are conducted under the implicit assumption that price stability will be as easy to maintain in the next decade as it was in the past. So, there would not be much to lose in “diverting” some of the power and credibility of monetary policy to seeking financial stability. It is very clear that this assumption is severely tested, perhaps sooner than we thought. It will be important, in this environment, to maintain clarity of purpose and robustness in institutional arrangements in order to limit the risk of weakening the benefits of Central Bank independence, which were so hardly won over the last decades. BIS central bankers’ speeches  3