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Christine Kaufmann and Rolf H Weber

Prior to the Great Financial Crisis (2008/9) Central Banks used a single instrument, control over the short term interest rate, to achieve a single inflation target. The experience of the GFC has led Central Banks to give much more emphasis to financial stability, reverting to an earlier historical tradition. To hit two objectives efficiently, two instruments are required. A second set of instruments, macro-prudential measures, has been developed for this purpose. Macro-pru measures differ from micro-pru, since the former should vary according to the state of the banking (or wider financial) sector as a whole and be applied across the board, whereas the latter relates to the individual institution. There is, however, a large overlap between macro-pru and monetary policy on one side, and macro-pru and micro-pru on the other. Given such overlaps there is a strong efficiency argument for combining the conduct of all three within the Central Bank, but this not only greatly extends the powers, but also blurs the mandate, of an unelected technocratic agency, which is problematical. Much may depend on how successful Central Banks become in employing macro-pru measures, such as counter-cyclical capital requirements and varying limits on housing finance, since experience with these remains quite limited.