The Future of Central Banking: Inflation Targeting versus Financial Stability
The Challenge
The global financial crisis 2008-2009 led to a profound rethinking of the pre-crisis monetary policy consensus. Since the great moderation until the year 2007, there was a remarkable convergence of monetary theory and monetary policy at central banks all over the world. This consensus can be summarized as „flexible inflation targeting“.
Most monetary economists agreed until the crisis that focusing on price stability and the stabilizing the output gap is a sufficient and appropriate mandate for conducting monetary policy. In particular, the consensus claimed that this mandate automatically leads to financial stability and that this framework appropriately deals with cross-border capital flows serving as transmission channel. The global financial crisis showed that this consensus is now seen as increasingly inadequate and insufficient.
Therefore, monetary economists and central banks increasingly broaden their view on financial stability as a major concern for the conduct of monetary policy. It is the main task for the monetary authority to maintain financial stability. Central banks all over the world launched the publication of a financial stability report and develop indicators reflecting the state of the financial system.
How much rethinking of monetary principles is needed after the crisis? How much of the pre-crisis consensus can be kept as monetary principles? In particular, the following questions need to be addressed:
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