Non-standard monetary policy and financial stability: developing an appropriate macrofinancial policy mix

Pill, H and Reichlin, L (2017) Non-standard monetary policy and financial stability: developing an appropriate macrofinancial policy mix. In: Preparing for the Next Financial Crisis: Policies, Tools and Models. Cambridge University Press, Cambridge, pp. 8-25. ISBN 9781107185593

Abstract

What are the potential risks of central bank balance sheet policies for financial
stability? The answer to this question depends on the type of balance sheet policies and on the
type of financial stability risk. Allowing central bank intermediation to substitute for private
intermediation when markets seize up tends to bolster financial stability. Such interventions
can be characterised as ‘circuit breakers’ that halt a potentially vicious downward spiral of
market dislocation and loss of market participants’ confidence. By contrast, central bank asset
purchases aimed at reducing returns on safe assets and pushing private investors further along
the risk and maturity spectra than they would otherwise choose to go may serve to generate
financial stability risks. This is the case if the primary concern for stability is the squeeze on
banks' profitability generated by a flat yield curve. On the other hand a flat curve decreases the
incentive for financial institutions to engage in maturity transformation thereby decreasing a
different source of financial stability concerns. Banks as a consequence become safer but less
profitable.