Why Is Financial Stability a Goal of Public Policy?

Abstract

A number of developments have combined to put the issue of financial stability at the top of the agenda, not just of supervisory authorities, but of public policymakers more generally. The growth in the volume of financial transactions and the increasing integration of capital markets have made institutions in financial sector more interdependent and have brought to the fore the issue of systemic risk. The crises in financial systems that have occurred have demonstrated the close linkages between financial stability and the health of the real economy. A distinction is commonly made between monetary stability and financial stability. Stability in financial institutions means the absence of stresses that have the potential to cause measurable economic harm beyond a strictly limited group of customers and counterparties. The resolution costs of financial sector crises are, of course, transfer costs. The most effective way of ensuring continued confidence in financial institutions is to provide their users with some sort of explicit safety net.

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