Back to the past - Central banks and their Role in addressing Financial Instability

The Great Financial Crisis has not only disrupted the economy but also drawn into question the dominance of the neoliberal paradigm in central bank policy making. In order to ensure financial stability macroprudential policy measures have been implemented in many countries. However, in the US they widely lack of an explicit theoretical framework since policy makers remain stuck in the 'old' New Keynesian perspective. This leads to blindness for fragility arising from the activities in credit markets and leaves the current macroprudential policy framework incoherent. A conscious change in the theoretical and cultural mindset towards a Keynesian- Minskian perspective would enable policy makers to recognize the importance of understanding and regulating the complex operations in today's money and capital markets. This change has to go hand in hand with a change in the organizational structure of regulatory institutions and the approach to macroprudential policy making. Giving the Fed an explicit mandate for financial stability could be the trigger of progress in all those areas. Although there is no definite answer to the question whether monetary policy should be influenced by stability considerations, it is important that the Fed does not remain ignorant about their significant influence on the evolution of financial fragility. Two sets of instruments, macroprudential and monetary policy should be used for two different objectives, financial stability and macroeconomic development. But both sets of instruments influence both objectives and therefore have to be considered together. The way forward is to remember the Fed's responsibility for the stability of the financial system; it was founded for, and to increase its role to address financial instability.