Federal Reserve Chairman Ben Bernanke said the 2008 financial crisis and subsequent Great Recession were reminders of a forgotten lesson: a central bank must account for risks in the financial system if it is to maintain healthy monetary policy.
Bernanke said the central bank could boost financial stability “by assuming the lender-of-last resort” function described by British economist and writer Walter Bagehot—the central bank uses its authority to provide liquidity to ease market conditions during periods of financial panic.
“The Fed’s many liquidity programs played a central role in containing the crisis of 2008 to 2009,” Bernanke said. “However, putting out the fire is not enough; it is also important to foster a financial system that is sufficiently resilient to withstand large financial shocks.”
Bernanke said that while monetary policy is tied to financial stability, the links “are not yet fully understood,” adding that the Fed aims to implement supervision and regulation as the first line of defense against systemic risk.
“In short, the recent crisis has underscored the need both to strengthen our monetary policy and financial stability frameworks and to better integrate the two,” Bernanke said. “We have made progress on both counts, but more needs to be done…Both research and experience are needed to help the Fed and other central banks develop comprehensive frameworks that incorporate all of these elements. The broader conclusion is what might be described as the overriding lesson of the Federal Reserve’s history: that central banking doctrine and practice are never static. We and other central banks around the world will have to continue to work hard to adapt to events, new ideas, and changes in the economic and financial environment.”