FINANCIAL strongSTABILITYstrong AND THE MACROECONOMY.pdf

CENTRAL BANK OF ICELAND WORKING PAPERS No. 9 FINANCIAL STABILITY AND THE MACROECONOMY by Frederic S. Mishkin May 2000 CENTRAL BANK OF ICELAND Economics Department Central Bank of Iceland Working Papers are published by the Economics Department of the Central Bank of Iceland. The views expressed in them are those of their authors and not necessarily the views of the Central Bank of Iceland. Also available on the Central Bank of Iceland World Wide Web site (http://www.sedlabanki.is) All rights reserved. May be reproduced or translated provided the source is stated. ISSN: 1028-9445 FINANCIAL STABILITY AND THE MACROECONOMY by Frederic S. Mishkin Graduate School of Business, Columbia University and National Bureau of Economic Research May 2000 Abstract This paper surveys the causes and macroeconomic consequences of financial instability. It emphasizes the key role of asymmetric information in causing financial instability and explores several recent instances of financial crises in industrial and emerging market countries. The paper then discusses the appropriate macroeconomic policies to reduce the risk of financial insta- bility and to promote recovery from financial crises, if they have occurred. It argues that Central Banks should be just as concerned with financial stability as with price stability. It emphasizes that financial stability is by no means incompatible with the goal of price stability. In fact, price stabi