DP10949 On the separation of monetary and prudential policy: how much of the pre-crisis consensus remains?

Author(s): Stephen G Cecchetti
Publication Date: November 2015
Keyword(s): capital requirements, financial stability policy, monetary policy, prudential policy, stress tests
JEL(s): E52, G01, G28
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10949

Prior to the crisis, monetary policymakers and prudential authorities had clearly defined tools and goals with little or no conflict. The crisis revealed a variety of overlaps, where one set of policies seem to influence those in another. Does this mean that two policy realms can no longer remain separate? I address the question by first asking whether monetary policy creates significant financial stability risks. My answer is generally no. Given that, central bankers should refrain from reacting to financial stability risks in most circumstances. Instead, the job of safeguarding the financial system should be left, as it was prior to the crisis, to prudential policymakers. But how can prudential policy best maintain financial stability? I argue that, given our current state of knowledge, stress tests are the best tool to ensure crisis will be rare and not terribly severe. So, my answer to the question in the title is that the pre-crisis consensus remains largely intact.