International Monetary Fun Managing Director Christine Lagarde said Sunday that monetary policy may need to ‘lean against the wind’ of emerging financial imbalances.
Speaking at the opening dinner of the ECB Forum on Central Banking in Sintra, Portugal, Lagarde said while marcoprudential tools had been effective in some areas, they remain largely untested.
“There is relatively limited experience with full-fledged macroprudential frameworks, especially in advanced economies,” Lagarde said.
Should prudential policies have shortcomings, “monetary policy may need to lend a hand in securing financial stability, by using interest rates to lean against the wind of emerging financial imbalances,” she said.
However, Lagarde cautioned that this may be easier said than done as policymakers will be confronted by new, complex questions.
“The first is about the transmission mechanism. Do we know, for instance, how much a 100 basis points increase in interest rates can deliver in terms of financial stability? Do we even agree on how to define financial stability? Should we measure it in terms of credit growth, asset price growth, or leverage?,” Lagarde asked.
Nevertheless, Lagarde underlined the interconnectedness of monetary policy and financial stability.
“The current environment in the euro area is a sobering reminder of how weakness in balance sheets can constrain the ability of banks to support credit and investment – ultimately contributing to low inflation,” Lagarde said.