Our job is to keep prices stable. We know that a stable financial system is good for price stability. Stable prices are good for the financial system too, as people and businesses are better able to plan and invest knowing prices will not change by much over time. That is why information about the health of the financial system plays an important role in our analysis and decisions.
Why was financial stability part of our strategy review?
The financial system is important
The financial system is a key part of our economy. It includes, for example, banks, insurance companies and financial markets. The financial system helps money flow through the economy when and to where it is needed. For this essential function to work well, we need the financial system to be stable. While other authorities are primarily responsible for this task, we also keep an eye on the stability of this system.
Financial stability is good for price stability, and vice versa
Our job is to keep prices stable. We do that using our monetary policy, which works through the financial system. When banks and markets are healthy, our monetary policy works better. In times of financial instability, it becomes harder for us to keep prices stable. Price stability is good for the financial system. People and businesses are better able to plan and invest in the knowledge that prices will not change by much over time.
The impact of the 2008 financial crisis
The financial crisis in 2008 showed just how important a stable financial system is. The crisis disrupted the flow of money across the economy. Financial markets became very unstable. It was very difficult to borrow money, and people and businesses suffered greatly. To help keep prices stable, we cut our interest rates and began introducing new tools. These decisions, alongside those of other policymakers, helped get the economy and the financial system back on track.
How does monetary policy affect the financial system?
By adjusting interest rates, we can influence prices
Monetary policy reaches people, businesses and governments through the financial system. By adjusting our interest rates, for instance, we can influence how expensive it is for people and businesses to borrow money from banks. That affects how much people and businesses spend and invest. This in turn influences how much things cost in the economy.
Very low interest rates and financial stability
Sometimes the financial system and monetary policy can affect each other in unwanted ways. The case of very low interest rates is a good example. Very low interest rates are helpful for price stability when the economy is doing badly. This has been the case in recent years. However, interest rates that are too low for too long may have unintended side effects on financial stability.
Very low interest rates may encourage some people and businesses to take on more debt than they can handle. Banks would not earn as much from making loans. Savers would not make much of a return on their savings. People and businesses may take riskier decisions. As a result, the financial system can become more unstable.
We keep an eye on side effects
We are watching out for any unwanted side effects of our monetary policy. While rules by other authorities to encourage responsible behaviour in financial markets are the key response, we also adjust some of our own tools to keep these side effects small.
On balance, unwanted side effects have been offset by good ones. For instance, banks might earn less now from lending money. But our monetary policy also helps banks because it stabilises the economy. That keeps people in jobs, allowing them to pay back their loans to banks or to take out new ones.
How should we take the importance of financial stability into account?
Rules are the first line of defence
Other authorities are responsible for ensuring financial stability in the euro area. Their rules promoting a more stable financial system are the first line of defence against the risk of another financial crisis.
Two sides of the same coin
But there is also a clear case for considering financial stability when we make our monetary policy decisions. That is because financial crises can put price stability in danger. Financial stability and price stability are two sides of the same coin. We always need to keep both sides in mind. That is why information about the financial system will always play an important role in our analysis and decisions.
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The role of financial stability considerations in monetary policy and the interaction with macroprudential policy in the euro area
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