Abstract

There is a remarkable consensus about the framework whereby a central bank should fulfill its macromonetary functions. In sharp contrast, there is no consensus about the framework for achieving its financial stability objective, either on the appropriate theory or practice. In this chapter we record how and why it has been so difficult to achieve consensus in this field. We start with a historical outline of central banks' financial stability role, describe their current functions in this respect, and then discuss the reasons why there has been, in recent years, such a diversity of views on the best way to organize the management of financial stability. In the second part of the chapter we ask how a satisfactory theoretical basis to address financial stability issues might be obtained. The first essential is that any such theory and model must be firmly based on a proper analysis of the probability of bank default (PD). We outline how such a model can be developed.

Introduction: The Financial Stability Role of Central Banks

On the macroeconomic policy side of central banking, a remarkable consensus has been emerging over the last two decades. This covers both the applicable theoretical framework for analyzing the transmission mechanism of monetary policy and also the appropriate institutional structure for the central bank to deploy its macroeconomic policies.