Jean-Pierre Landau: The role of central banks – lessons Remarks by Mr Jean-Pierre Landau, Deputy Governor of the Bank of France, at the VIth International Symposium of the Banque de France on “Which regulation for global imbalances?”, Paris, 4 March 2011. *  *  *  I am going to talk about the relationship between monetary policy and financial stability. This topic is abundantly debated. I will take, however, a modest approach and deal only with some operational aspects. These are, nevertheless, crucial since the essence of modern Central Banks is their operational independence. It is therefore relevant to ask how it might be affected or impacted by the search for greater financial stability. The starting point is that financial frictions matter. They matter both for financial stability, which is obvious, and for the transmission of monetary policy, a point which should have been obvious but was somehow forgotten. Prior to the crisis, most of our macro models tended to represent the transmission mechanisms through a simple, immaculate, intertemporal substitution effect whereby changes in policy rates would induce expenditures shifting across time. Money and financial institutions play almost no role in that mechanism, as credit was implicitly supposed to respond only to interest rate movements. What do the words “financial frictions” exactly mean? I will interpret those terms as encompassing the conjunction of maturity transformation and leverage which drives the expansion or contraction of financial institutions’ balance sheets, thus the overall equilibrium in credit markets, including securitized markets.

In the period ahead, the one-week repo rate will remain our main policy tool, and we will continue to implement the monetary policy within a simplified operational framework. The inflation-focused monetary policy will be our strongest weapon that will serve as a shield against global fluctuations and financial market volatilities. Our determination to fight with inflation will secure the strength and prestige of the Turkish lira. 3 In the current period, high levels of inflation and inflation expectations require a tight monetary policy stance. The monetary stance will continue to be determined in view of inflation developments and inflation expectations, and at a degree of tightness that will rapidly restore the disinflation process and ensure its sustainability until we achieve our medium-term targets. Until there are strong indicators that point to a permanent fall in inflation, we will continue to set the policy rate at a level above inflation, in a manner to maintain the strong disinflationary effect. To sum up, we will make our decisions with a data-centered perspective, taking into account all macroeconomic data flow, inflation in particular. In the new period, we will make the best use of our corporate capacity to ensure a permanent fall in inflation. It should be noted that the stability to be achieved in the general level of prices will positively affect macroeconomic and financial stability through the fall in country risk premiums, the start of reverse currency substitution, the uptick in foreign exchange reserves, and a permanent decline in financing costs.