Financial stability and monetary policy
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It is useful to distinguish between financial conditions and financial stability. Financial conditions reflect the cost of and access to funds of borrowers, households and businesses. Financial stability reflects the lack of significant financial vulnerabilities and resilience of the financial sector to shocks. Loose financial conditions for a long period of time can lead to a buildup of financial vulnerabilities that can have costly macro consequences. There also are times when the economy is recovering and the financial system is weak, and loose financial conditions support stable growth. I think the Fed could communicate that when they loosen monetary policy and financial conditions, it is to support growth and tighten the volatility of economic growth. At the same time, the Fed could communicate its thinking on whether the financial system is resilient enough that this loosening of conditions is not contributing to further vulnerabilities. For a risk management approach to conducting monetary policy, central banks need to think about more than expected growth, but also risk to that growth. Financial conditions tend to cause greater downside risks to growth than upside risks.