Navigating Trade-Offs between Price and Financial Stability in Times of High Inflation

Author: Romain Bouis, Mr. Damien Capelle, Mr. Giovanni Dell'Ariccia, Christopher J. Erceg, Maria Soledad Martinez Peria, Mouhamadou Sy, Mr. Ken Teoh, and Mr. Jerome Vandenbussche

Central banks may struggle to balance price stability and financial health when inflation is high and financial stress rises. Tools exist to help, but limitations and country specifics can complicate this goal, requiring flexible policies.

Volume/Issue: Volume 2025 Issue 003

Publication date: April 2025

ISBN: 9798229005135

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Topics covered in this book

This title contains information about the following subjects. Click on a subject if you would like to see other titles with the same subjects.

Banks and Banking , Finance , Inflation , Economics- Macroeconomics , Money and Monetary Policy , Monetary Policy , Financial Stability , Policy Coordination , Macroprudential policy , Interest rate policy , Financial sector stability , Inflation targeting , Inflation , Financial sector risk , Nonbank financial institutions , Price stabilization , Central bank policy rate , Liquidity , Monetary tightening , Global

Also of interest

The Return to Fiscal Rules

The State as Financier of Last Resort

Industrial Policies: Handle with Care

Inflation and Bank Profits: Monetary Policy Trade-offs

Summary

Trade-offs between price and financial stability can occur when inflation is above target and financial stress is rising. Use of central bank liquidity tools and other financial stability policies may, under some circumstances, allow central banks to maintain their inflation fighting stance, while addressing financial stress. However, challenges in deploying these tools and specific country characteristics may hinder central banks’ ability to achieve both price and financial stability. In such circumstances, central banks should account for financial stress increasing downside risks to activity, allow for slower disinflation using monetary policy flexibility, and communicate that deviations from the medium-term inflation target are temporary. Countries with weak central bank credibility, high exposure to exchange rate movements, and limited fiscal space face extra challenges in managing these trade-offs and might have to rely on foreign exchange interventions, macroprudential policies, capital flow measures, and international liquidity tools.