Changes in the monetary policy approach and framework after a crisis were discussed in a session in the Seventeenth World Congress held in Dead Sea, Jordan during June 06-11, organised by the International Economic Association and the United Nations. The session was chaired by renowned Nobel laureate economist Joseph Stiglitz where country cases were presented on the experiences and outcome of monetary policies. As observed in the available literature and also discussed in the session, the recent global crisis brought notable changes in the approach and framework of monetary policy. Since the recent global financial crisis, there has been an ongoing debate on whether monetary policy should incorporate a financial stability objective. The role of macro prudential regulation in achieving financial stability was high on the agenda of policymakers.
The global financial crisis has brought new challenges in regards to the monetary policy and some explicit questions: What should be the new approach and framework of monetary policy? What could be the costs of using monetary policy actions to address potential risks to financial stability? How do monetary policy actions affect financial stability issues? Should macro prudential policy be used to mitigate financial systemic risk? In that context, the issue of using monetary policy and macro-prudential policy to address financial stability emerged and captured the attention of many academics and policymakers in recent years.
Conventionally, there are arguments that the objectives of 'financial stability' and 'price stability' may contradict each other and thus the objective of price stability may be hampered. Thus, policymakers and the segment of the economics professionals interested in central banking focused on the task of attaining and preserving price and economic stability. Targeting explicitly 'financial stability' was generally viewed as a distraction and risking the central bank's attention to achieving its price stability mandate. And thus policymakers were not often a point to financial stability concerns as relevant to their monetary policy decisions. This approach can be observed in the charters of several central banks. The rise of financial stability concerns is a natural reaction to the events like the global financial crisis, when financial systems in many countries almost toppled the global economy. Some argue that the policy interest rate, which is traditionally used to achieve macroeconomic (price) stability, may not be successful in containing financial instability. If central banks have two objectives (price stability and financial stability), two separate policy instruments might be needed -- the policy interest rate and a macro-prudential instruments. This appears to suggest that monetary policy using one instrument may not successfully achieve price/macroeconomic stability and financial stability, and therefore it builds the case for utilising also macro-prudential tools.
The renewed recognition of the importance of preserving financial stability is entirely appropriate and perhaps long overdue. However, the current discussion of the relationship between financial stability and monetary policy has mostly lacked a rigorous theoretical and empirical analysis. Unlike the extensive literature on monetary policy rules and optimal monetary policy, our understanding of the interactions between monetary policy and risks to financial stability remains limited. Practically, widespread discussions are on regarding the appropriate role of monetary policy in supporting financial stability, where further progress is badly needed.
Practically, all are aware of the importance of having a robust, resilient financial system. It has become a hymn in central banking to declare that robust micro- and macro-prudential regulatory and supervisory policies should provide the first and second lines of defence for financial stability. The challenge for policymakers is to better understand the sources of these risks and the instruments that can be devised to reduce them for ensuring financial stability. A strong monetary policy transmission mechanism is needed to oversee price stability and financial stability by the central banks. Indeed, a well-functioning financial system strengthens the monetary policy transmission mechanism.
Some central banks of developing countries like Bangladesh Bank have opted to deviate from the mainstream monetary policy approach of developed economies. These central banks have been following monetary and financial policies towards supporting inclusive and sustainable growth. BB's monetary policy approach attempts to serve Bangladesh economy in upholding growth and stability and have been experiencing macro financial stability amid domestic shocks and external turbulences, including the last global financial crisis. Thus, the outcome so far has been positive and encouraging in regard to maintaining financial stability in the country. Monetary policy approaches of many other developing economies central banks have variants of similar inclusiveness and sustainability-supportive aspects. Based on the experiences of several developing countries, it can be stated that price stability, the primary objective of monetary policy, does not occur in isolation rather financial stability is an important requirement for ensuring price stability.
Professor Joseph Stiglitz attempted to explain the recent global economic and financial crisis and examine the reasoning in his lecture programme titled 'Towards a General Theory of Deep Downturn' on June 10 in the Seventeenth World Congress. In his discussion Prof. Stiglitz has noted the crisis was made and created by the economic systems. He has added that global economies face crises and new insight comes up. Studying crisis provides us insight into the behaviour of economic systems in different economic situations. Today the Capitalist Economy is also called Credit Economy and misallocation of resources and asymmetric information come up as critical responsible factors for the crisis, Mr Stiglitz has pointed out. According to Prof Stiglitz, market imperfection contributes to creation of a crisis situation, especially, financial market imperfection is very critical.
Financial stability and credit distribution after a crisis were discussed in the contexts of Japan, UK and Jordan economies where country cases were presented. Of these, Japan's approach was unusual. Japan followed unconventional monetary policy with close to zero interest rate since early twentieth century. And as part of policy instrument to stimulate the market, quantitative easing policy was employed by the Bank of Japan in 2001. Following a crisis, Japan brought a major change in the monetary policy framework by introducing the quantitative and qualitative monetary easing and inflation targeting framework, which aims to achieve an inflation rate of 2 per cent in terms of CPI within the range of 2 years. Japan's policy of engaging public sector to improve the investment demand has worked well. Regulatory weaknesses allowed significant risks to build up, and enabled the bursting of the US housing bubble to turn into a major global crisis, as opined by the discussants of the lecture programme. There was consensus among speakers that more emphasis should be allocated on financial stability, especially from a systemic risk and macro perspective monetary policy should not ignore financial cycles, asset price booms, and credit allocation.
The crisis highlighted sudden changes in credit, trust and perception of risks. Today it is recognised that simply lowering the interest rate to stimulate the market may not work. Credit must go to the productive sector [not to buy land] to create real capital and it must push up the effective demand. Hidden subsidies must be identified that may divert funds to the unproductive sectors. The financial stability function should get due emphasis. The belief that the government is there to save banks is rather supporting banks to undertake more risks. That is creating the problem of moral hazard. Today no-one really monitors a big bank i.e. the intention and capacity of a big bank to handle its own risks is essential. Thus, it is crucial to enhance the capacity of banks as a credit providing institution to ensure the productive use of credit. Capacity of banks should be improved and portfolio distribution in credit should get due attention in banks. As part of a sound financial system, banks must ensure low transaction costs in their intermediation process. Access to credit is crucial and thus developmental roles of banks and central banks are expected to play a positive role in a sound financial system. Credit availability should be monitored, and one needs to explain the supply of credit, as credit can be created by a financial institutions out of nothing. Aggregate demand should be connected with credit availability and risk management issues should get due emphasis. It is to be noted that use of risk management derivatives may support, but are costly. It means the beneficiaries of the derivatives are practically the banks, not the common people in general. In the context of several countries the role public sector has been positive. Thus in certain cases, the government should itself use its own credit capacity through high return public investment.
Bangladesh is among the countries that were not severely affected by the crisis. However, the experiences have offered notable lessons for the developing countries like Bangladesh. In recent years, notable initiatives have been taken by the Bangladesh Bank to ensure appropriate regulatory and supervisory regimes for effective oversight of risk management, internal controls and customer interest protections. Bangladesh Bank has been providing sufficient space in its monetary programme for lending to activities which support broad-based investment and inclusive growth objectives. It has been using both monetary and financial sector policy instruments to achieve these goals. For promoting economic and financial stability, the BB adopted a financial inclusion and developmental finance campaign to reach the underserved by helping channel credit away from destabilising activities and toward productive investments.
(The writer is Professor and Director [Training], BIBM). E-mail: ahsan@bibm.org.bd)
© 2026 - All Rights with The Financial Express
