August 2020

Monetary Policy Strategies and Tools: Financial Stability Considerations

Jonathan Goldberg, Elizabeth Klee, Edward Simpson Prescott, and Paul Wood

Abstract:

This paper examines potential interactions between financial stability and the monetary policy strategies and tools considered in the Federal Reserve’s review of monetary policy strategy, tools, and communication practices. Achieving the Federal Reserve’s goals of full employment and price stability promotes financial stability. A key concern, however, is that with a low equilibrium real interest rate, a low policy rate will be necessary, and in turn, these low rates may contribute to an increase in financial system vulnerabilities. Our analysis suggests that there are typically significant macroeconomic and financial stability benefits of using these tools and strategies, but there are plausible situations in which financial vulnerabilities are such that it would be desirable to limit their use. A clear communications strategy can help minimize financial vulnerabilities. Should vulnerabilities arise, they are often best addressed with macroprudential tools.

Keywords: U.S. monetary policy, financial stability, macroprudential policy.

DOI: https://doi.org/10.17016/FEDS.2020.074

PDF: Full Paper

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Last Update: August 27, 2020