Many central banks around the world place a high value on financial stability. Even though there is no single definition of financial stability, several economists and policymakers agree that it is necessary or even necessary for monetary policy to function properly. This is especially true given the possibility of major financial market shocks dampening economic activity (Billi & Vredin 8). Central banks have valid reasons of including the objective of financial stability in their monetary policy agenda
In order for a central bank to realize its objectives, it may employ two kinds of policy tools. One set of tools might be called monetary policy and entails the short-term interest rates levied on loans extended to commercial banks by the central bank, but probably also other conditions for such loaning. The other policy might be the macroprudential policy instrument such as liquidity requirements for commercial banks and limitations on household debt vis-a-vis assets pledged (LTV ratios) or in relation to one's income (LTI rations) (Billi & Vredin 9).
3. The central bank's role to modern money markets
Central banks, within the financial system, steer interest rates via the interbank market. The interest rates coupled with other conditions developed by central banks on their deposits from or short-term lending to the commercial banks have an impact on interest rates prevailing in the interbank market. Thus central banks' decisions have indirect effects on borrowing rates through financial markets and banks (Billi & Vredin 12).
Works Cited
Roberto Billi, Anders Vredin. "Monetary policy and Financial Stability ." Sveriges & Riskbank Economic Review Journal (2014): p1-15.
