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Symposium 2012

Solution for The Future of Central Banking: Inflation Targeting versus Financial Stability

The Challenge

The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which cent ...

The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which central banks focus on maintaining price stability and stabilizing the output gap—was an appropriate and sufficient mandate for conducting monetary policy. Key assumptions underlying the consensus were that this mandate would automatically lead to financial stability and that the framework of monetary policy could deal with cross-border capital flows.

Delivering price stability must remain central banks’ primary goal.

In times of crisis, central banks can act as a "fire service" through the tools of liquidity management and unconventional monetary instruments. In some cases, these interventions are necessary to prevent a collapse of the payments system and to maintain financial stability.

For example, "quantitative easing" is an appropriate approach at the current stage of the global economic recovery. Further actions of this kind by the Federal Reserve and the European Central Bank should be supported if the central banks purchase the right assets at the right time to provide liquidity effectively.

But these measures should always be temporary in nature. Central banks should only act as a liquidity provider in a crisis and they should not permanently prevent necessary economic adjustment after a crisis. Longerlasting financing of insolvent market participants may threaten central banks’ primary goal of maintaining price stability.

    Related Solutions

    Solution
    Symposium 2012

    Central banks should adopt "default countercyclical policy," using the "comply or explain" approach.

    Central banks should adopt "default countercyclical policy," using the "comply or explain" approach.

    Central banks should adopt "default countercyclical policy," using the "comply or explain" approach.

    Polity
    Solution
    Symposium 2012

    Create a World Monetary Authority to promote a multilateral approach among central banks.

    Create a World Monetary Authority to promote a multilateral approach among central banks.

    Create a World Monetary Authority to promote a multilateral approach among central banks.

    Polity