the financial system ’ s ability to absorb negative shocks, and so when a shock arrives, losses mount, the financial system weakens, lending slows, and economic activity slows by more than it would have otherwise, potentially leading to an economic downturn or a more severe recession. should financial vulnerabilities affect the stance of monetary policy? these observations lead to the important question of whether and how financial vulnerabilities should affect the setting of monetary policy. one simple framework for evaluating the tradeoffs associated with actively setting monetary policy to lean against the buildup of financial vulnerabilities is to examine the costs and benefits of such a policy in terms of unemployment and inflation. in this approach, the costs of tightening monetary policy in response to a buildup of financial vulnerabilities are lower employment and potentially below target inflation in the near term. the benefits are possibly reducing the risk of a future financial crisis, an event likely associated with a much larger fall in employment and inflation. one view is that monetary policy curbs household and business borrowing only modestly but can boost the unemployment rate notably. and so using monetary policy to damp borrowing does more harm than good. according to this view, using monetary policy to lean against financial vulnerabilities does not generate significant net benefits and may be counterproductive — increasing unemployment and decreasing inflation below a desired level with little reduction in risks to financial stability. 4 at the same time, some research has identified circumstances under which the benefits of using monetary policy to lean against financial vulnerabilities could outweigh the costs. 5 a key consideration is the estimated amount of economic activity lost in a financial crisis — and some research suggests such losses may be quite large, which raises the benefits of leaning against imbalances. similarly, monetary policy may affect a broad range of financial imbalances — excessively high house or equity prices and leverage within the financial sector — and the full set of these effects could shift the risk of financial instability sufficiently, at least under some circumstances, to make leaning against financial vulnerabilities with monetary policy desirable. the broader point is that we do not fully understand the cost – benefit tradeoff and whether monetary policy adjustments for financial stability reasons may be appropriate at some times. whither macroprudential policy? of course, there is one additional and critical factor to consider when weighing adjustments to the stance of monetary policy for financial stability reasons : the availability and efficacy of other instruments to promote financial stability

the auspices of the financial stability board. third, macroprudential policies that are targeted to banks may create an incentive for financial intermediation to migrate outside of the regulated banking system. the vulnerabilities may still emerge, albeit elsewhere in the financial system — perhaps in institutions or structures that are less stable and resilient than our banks. in part reflecting these incentives, we regularly monitor financial intermediation both inside and outside of the banking system. summary to sum up, while there is evidence that financial vulnerabilities have the potential to translate into macroeconomic risks, a general consensus has emerged that monetary policy should be guided primarily by the outlook for unemployment and inflation and not by the state of financial vulnerabilities. financial system resilience, supported by strong through - the - cycle regulatory and supervisory policies, remains a key defense against financial system and macroeconomic shocks. there is a clear need for new theory and empirics to address the questions about monetary policy and financial stability i have posed today. i encourage you to continue to contribute to these answers. by engaging the help of the wider academic community, conferences such as this one provide an invaluable opportunity to make progress on issues of great importance for economic policy. references adrian, tobias, nina boyarchenko, and domenico giannone ( 2019 ). “ vulnerable growth, ” 3 / 4 bis central bankers'speeches american economic review, vol. 109 ( april ), pp. 1263 – 89. adrian, tobias, and nellie liang ( 2018 ). “ monetary policy, financial conditions, and financial stability, ” international journal of central banking, vol. 14 ( january ), pp. 73 – 131. ajello, andrea, thomas laubach, david lopez - salido, and taisuke nakata ( 2019 ). “ financial stability and optimal interest rate policy, ” international journal of central banking, vol. 15 ( march ), pp. 279 – 326. bernanke, ben s., and mark gertler ( 1995 ). “ inside the black box : the credit channel of monetary policy transmission, ” journal of economic perspectives, vol. 9 ( fall ), pp. 27 – 48. boivin, jean, michael t. kiley, and frederic s. mishkin ( 2010 ). “ how has the monetary transmission mechanism evolved over time? ” in benjamin m. friedman and michael woodford, eds., handbook of monetary economics