In both the GFC and March 2020 ‘dash for cash’, QE programmes increased liquidity in otherwise illiquid markets[9], supporting financial stability. There is however less experience on how this might operate in reverse. Now all the channels I just outlined work in two directions – tightening or loosening monetary policy – as well as over short and longer term horizons. While the effects are complicated and variable, at a high level I think about it like this: In the short-run, loosening monetary policy tends to support financial stability. For example, lower interest rates will reduce borrowers’ costs and the risk of insolvencies[10]. In the long-run though, the effects could reverse. Long periods of low interest rates might lead to a build-up of financial stability vulnerabilities, such as excessive borrowing[11] and asset price bubbles[12]. So there are clearly important ways in which changes in monetary policy can affect financial stability, even if in the end the two are complementary. Monetary policymakers also have reasons to care about financial stability. Financial instability can affect the economy directly whether by causing or by amplifying shocks – we saw that very clearly in the GFC. Another reason is that for monetary policy to work effectively, the financial system needs to ‘transmit’ it to the rest of the economy. So it matters for monetary policy makers whether the banking system is impaired, as in the GFC[13], or if gilt markets are in a spiral of forced selling, as in autumn 2022[14]. An unstable financial system is a problem for monetary policy.

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