The trade-off between inflation and interest rates has never been more important, said Bank of England governor Andrew Bailey in a speech last week – but, the separation between monetary policy and financial stability must also be carefully navigated.
In a speech given at The Federal Reserve Bank of Kansas 2024 Economic Symposium, in Jackson Hole, Wyoming, Bailey suggested, in light of the need to balance both monetary policy and financial stability objectives, a return to the “classical gold standard era of central banking”.
“Recent experiences indicate the larger role of the financial stability objective in modern central banking in contrast to the orthodoxy of the post-1970s era when monetary policy alone came to the fore. This rebalancing in some ways takes us back to the earlier classical gold standard era of central banking,” Bailey posited.
Bailey also suggested that policy setting will need to remain restrictive long enough for inflation to hit the bank’s 2% target. “The course will therefore be a steady one,” Bailey added.
The governor highlighted the difficulties of navigating such a course in the wake of major events such as the pandemic and the Ukraine war, and how central banks must mitigate these pressures while maintaining financial stability and reducing inflation.
Highlighting the UK’s Liability-Driven Investment (LDI) crisis, which began in September 2022 after the Truss government’s mini-budget caused a sell-off in Gilts, Bailey said this was a financial stability, not monetary policy, event, “and the challenge was to structure the intervention and communicate it in a way that reinforced this point”.
In lieu of the LDI event, building strong financial stability “buffers” is the best way to support resilient and competitive financial systems and strong economies, Bailey suggested. “Market events like those of two weeks ago or so will happen; the test is not whether they happen but whether they trigger wider instability. As central banks we operate within systems that are framed by law and institutions to create and preserve stability and prosperity in the public interest.”
Jo Burnham, OpenGamma, said: “The steep rise in initial margin post the mini budget illustrates the fragility of our financial system when under extreme stress. It’s a stark reminder of the importance of strong stress testing to anticipate and mitigate such liquidity crises. These measures are essential for ensuring the resilience of financial markets in the face of unforeseen economic shocks.”
©Markets Media Europe 2024
