Inflation targeting and financial stability: providing policymakers with relevant information

BIS Working Papers No 503
July 2015

Experience from financial crises and central bank policies in the past decade has led to an intensified debate about the relationship between monetary policy and financial stability. Since there is no established theoretical framework for analysing the links between financial stability and monetary policy, it is very difficult to deliver precise recommendations for policy. The primary purpose of this paper is to present suggestions for how risks of financial instability can be taken into account in the information provided to central bank decision makers, despite the considerable uncertainty about the appropriate analytical approach. The paper starts with a discussion of the strategy of "flexible inflation targeting", which, in fact, does not provide any "simple rules" for policymakers. The next section contains a review of theoretical and empirical analyses of links between financial stability and monetary policy. Insights from inflation targeting, and more recent views on the role of financial stability, lead to suggestions regarding the type of information that should be presented to monetary policy decision makers, and how it can be organised, to help them understand the links between financial stability and monetary policy.

JEL classification: E44, E52, E58, G18, G28

Keywords: monetary policy, financial stability, inflation targeting, central banks, financial crisis, financial frictions