Monetary policy and financial stability in the aftermath of the global financial crisis
Central banks in middle-income countries need to rethink the links between monetary policy, macroprudential regulation, and economic stability.
Theoretical and quantitative models developed by our researchers have revealed how central banks could use monetary policy and macroprudential tools to promote macroeconomic and financial stability. The research has influenced high level policy discussions between some of the world’s major central banks on the benefits and costs of new financial and regulatory mechanisms.
Our cutting-edge research looked into ways in which central banks in middle-income countries could use monetary policy and macroprudential regulation to promote economic stability. This path-breaking analysis has received immediate international interest and has influenced national and international debates on the role of monetary and macroprudential policies.
Key applications of the research
- Presentation to the European Central Bank, the OECD, the World Bank, the Financial Stability Board, the Basel Committee on Banking Supervision, and G20 central banks
- Establishment of a new Macroprudential Regulation Department and a monetary research programme in the Central Bank of Brazil (BCB)
- Inclusion in one of BCB’s core monetary models used to inform the bank’s regular policy meetings
- Influencing monetary policy analysis and on-going policy development in the Central Bank of Turkey (CBT)
- Development of a new forecasting model in the Central Bank of Morocco, used by the bank’s analysts to inform quarterly macroeconomic forecasts, inflation reports and background policy documents prepared for meetings of the bank’s Monetary Policy Committee
The research team, led by Prof Pierre-Richard Agénor, used small theoretical and applied macroeconomic models where credit market imperfections play an essential role, in line with the evidence on the financial systems that prevail in middle-income countries. Much of the research was in collaboration with the World Bank, BCB, and CBT, as well as Williams College, Massachusetts.
The research agenda focused on the relationships between monetary policy, macroprudential regulation, and economic stability, accounting in particular for:
- Features of the monetary transmission mechanism in a bank-dominated financial system;
- The influence of different bank capital regulatory regimes and how they affect the transmission of shocks to the financial system, as well as inflation and economic activity;
- Alternative channels through which fluctuations in financial variables may affect macroeconomic and financial stability.
The findings from the research led the research team to propose a new monetary policy regime for middle-income countries, dubbed ‘Integrated Inflation Targeting’ (ITT), in which the central bank holds an explicit financial stability mandate.
In countries implementing ITT, the policy interest rate should respond directly to excessively rapid credit growth. Monetary and macroprudential policies should be calibrated jointly to achieve macroeconomic and financial stability.
ESRC-DFID 'Growth Research Programme' (DEGRP)
Prof Agénor has recently been awarded funding to lead a major research project under DEGRP; "Financial Volatility, Macroprudential Regulation and Growth in Low-Income Countries." This project brings together a large group of co-investigators, including Dr Kyriakos Neanidis, alongside senior researchers in France, Africa, and international organizations such as the International Monetary Fund and the World Bank. It involves a blend of theoretical and empirical research, aimed at shedding light on how financial regulation can best be designed and implemented in low-income countries, without adversely affecting prospects for economic growth and poverty alleviation. Prof Agénor's contribution to the project will continue and extend the work on macroprudential regulation that he initiated with central banks in middle-income countries.