When monetary policy for financial stability backfires: communication with strategic banks
File(s)
Published version
Author(s)
Bonomi, Giampaolo
Uppal, Ali
Type
Journal Article
Abstract
We develop a model in which the central bank incorporates financial stability concerns into its monetary policy and communication decisions, while systemic banks strategically choose portfolios to influence policy. Because fully responding to economic shocks would generate policy surprises that threaten bank stability, the central bank underreacts to those shocks, consistent with the Federal Reserve’s response during the 2023 banking crisis. Anticipating this accommodation, banks tilt their portfolios to increase the financial-stability costs of rate hikes, pulling monetary policy toward lower rates while giving the central bank an incentive to announce higher future rates than it expects to set. Financial stability concerns can therefore backfire, creating a novel responsiveness–credibility trade-off: the more the central bank accommodates banks’ exposures ex post, the less credible its forward guidance becomes ex ante, making it harder for banks to align their portfolios with future policy and leaving them more exposed to policy surprises. Even when society values financial stability, it benefits from appointing a central banker who places less weight on it. Paradoxically, even banks may prefer such a central banker when the benefits of more credible guidance outweigh the loss of policy influence.
Date Issued
2026-10-01
Date Acceptance
2026-09-13
Citation
Journal of Economic Theory, 2026, 237
ISSN
0022-0531
Publisher
Elsevier BV
Journal / Book Title
Journal of Economic Theory
Volume
237
Copyright Statement
© 2026 The Author(s). Published by Elsevier Inc. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/).
License URL
Publication Status
Published
Article Number
106253
Date Publish Online
2026-09-16