•  The fact that monetary policy has an impact on financial stability does not necessarily mean that it should directly seek to achieve it. Monetary policy and financial stability: uncomfortable bedfellows? Let me offer two reasons why operationalising a financial stability role for monetary policy may be difficult. Leaning against winds from opposite directions? First, conflicts could arise between the price stability and financial stability objectives. •  Financial cycles are typically longer than business cycles, and the two cycles may diverge. •  The interest rate appropriate for price stability may not be consistent with financial stability. •  How does one lean at the same time against two winds blowing from opposite directions? One reason why the winds might blow from opposite directions, especially for emerging economies, is the role played by international liquidity and capital flows. •  Philip Lane has detailed the strong inter-linkages between global liquidity conditions, international debt flows, and domestic credit conditions. •  Maurice Obstfeld argues that because of the impact of financial globalisation, monetary policy carries a big burden trying to achieve both financial stability and macroeconomic stability. The experience of Emerging Asia during 2010–2013 is illustrative. •  Asian economies were broadly in full employment with low inflation and some downside risks to growth from the Eurozone crisis. 4  Borio, C and Zhu, H (2008), “Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism?” BIS Working Papers, No. 268, Bank for International Settlements, December.
4  BIS central bankers’ speeches  And the microprudential framework has indeed been strengthened post-Crisis. The Basel III reforms will go quite some way to make banks more resilient and financial systems safer. •  The quantity and quality of capital have been increased. •  There is for the first time, a global liquidity standard. •  There will soon be a direct cap on bank leverage. •  Systemically important banks will be subject to higher loss absorbency and more intrusive supervision. Besides these reforms, I would add that traditional microprudential limits that apply “through the cycle” are just as important in helping to maintain financial stability. If volatility in the real estate sector has repeatedly been shown to contribute to financial imbalances and distress: •  does it not make sense to put limits on financial institutions’ exposures to real estate? •  does it not make sense to require that loan-to-value ratios for property loans be less than 100%? •  does it not make sense to require the loan underwriting process to incorporate an assessment of the debt service ratio? I do not know if the Global Financial Crisis could have been avoided if interest rates in the US had been higher in the preceding years as some have argued. •  I do suspect though that if there had been prescribed loan-to-value ratios and debtservice ratios, the sub-prime problem may not have grown to such proportions.