Monetary policy as financial stability regulation. The Quarterly

This articledevelops a model that speaks tothegoals andmethods of financial stabilitypolicies. Therearethreemainpoints. First, froma normativeperspective, the model defines the fundamental market failure to be addressed, namely, that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, it shows how in a simple economy where commercial banks are the only lenders, conventional monetary policy tools such as open-market operations can be used to regulate this externality, whereas in more advancedeconomies it may be helpful tosupplement monetary policy with other measures. Third, from a positive perspective, the model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust frictionlessly and there are other transactions media besides bank-created money that are outside the control of the central bank. JEL Codes: E58, G01. I