Central Banking: Theory and Practice in Sustaining Monetary and Financial Stability

Chapter 12Financial StabilityIntervention Tools

Learning Objectives

1. Describe various tools that central banks can use to mitigate risks in the macroeconomy in order to sustain financial stability ex ante and ex post.
2. Describe various tools that central banks can use to mitigate risks in financial institutions in order to sustain financial stability ex ante and ex post.
3. Describe various tools that central banks can use to mitigate risks in financial markets in order to sustain financial stability ex ante and ex post.
4. Distinguish between Basel I, Basel II, and Basel III.

In Chapter 11 we reviewed some of the tools that can be used for monitoring and identifying financial stability risks. In this chapter we look at some of the tools that central banks might use to intervene, safeguard, and restore financial stability. Following the analytical framework used in the previous chapters, we review the tools in the context of three focus areas: (1) the macroeconomy, (2) financial institutions, and (3) financial markets. In each of the focus areas, we look at the tools that are meant to be used ex ante (i.e., sustaining financial stability by reducing the probability of a crisis happening, or reducing the severity of losses given a crisis), and those that are meant to be used ex post (i.e., managing a crisis that is unfolding, or providing a recovery resolution).

12.1 THE MACROECONOMY

The key tools that the central bank might use to intervene and maintain financial stability in the ...