Working Paper: NBER ID: w16883
Authors: Jeremy C. Stein
Abstract: This paper develops a model that speaks to the goals and methods of financial-stability policies. There are three main points. First, from a normative perspective, the model defines the fundamental market failure to be addressed, namely that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, it shows how in a simple economy where commercial banks are the only lenders, conventional monetary-policy tools such as open-market operations can be used to regulate this externality, while in more advanced economies it may be helpful to supplement monetary policy with other measures. Third, from a positive perspective, the model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust frictionlessly and there are other transactions media besides bank-created money that are outside the control of the central bank.
Keywords: monetary policy; financial stability; banking regulation; market failure
JEL Codes: E58; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conventional monetary policy tools (E52) | regulation of excessive issuance of short-term debt by banks (G28) |
| conventional monetary policy tools (E52) | financial stability (G28) |
| Unregulated private money creation (E42) | excessive issuance of short-term debt by banks (F65) |
| excessive issuance of short-term debt by banks (F65) | vulnerability to financial crises (F65) |
| monetary policy (E52) | bank lending (G21) |
| monetary policy (E52) | real activity (E23) |