Feb 03, 2010

"Should monetary policy and banking regulation be conducted by separate bodies? This column proposes a new policy framework whereby the central bank chooses short-term interest rates and the aggregate equity ratio while banking regulation and supervision, including the determination of bank-specific capital requirements, would be left to separate bank-regulatory authorities.

The current crisis has placed a fundamental question at the centre of policy discussion: “Should monetary policy and banking regulation be conducted separately?” Opinions differ – see Adrian and Shin (2009), Goodhart (2008), and De Larosière et al. (2009).

• Brunnermeier et al. (2009) argue that central banks should be tasked with macroprudential regulation.
• De Grauwe (2007) argues that central banks should be responsible for the supervision of all institutions involved in the business of creating credit and liquidity.
• Linking both policy areas directly, however, might endanger the exceptional success of many central banks in creating low and stable inflation of the kind observable during the last two decades (Gerlach et al. (2009)).

There is thus a pressing need to clarify the objectives and instruments of central banks and banking supervisory authorities, and also to inquire how they should ideally interact. Here I present a new framework aimed at such a clarification."

Click to go to the VOX EU website and view the entire column.