FRANKFURT (MNI) – The recent crisis has highlighted the need for
central banks to take account of financial factors, including credit and
monetary aggregates, to better gauge fundamental changes in the
financial sector, European Central Bank Executive Board member Lorenzo
Bini Smaghi said Friday.

“If central banks had taken the signals coming from strong monetary
and credit growth in mid-decade more seriously, monetary policy
decisions might have been better calibrated to contain the financial
imbalances that ultimately led to the financial crisis,” the central
banker said in a speech to be given in Toronto and provided in advance
by the ECB.

“Experience points to a need to deepen and broaden such analyses to
take better account of the fundamental changes observed in the financial
sector over recent decades. New aggregates and indicators need to be
developed,” Bini Smaghi added. “Work at the ECB is proceeding in this
direction.”

Bini Smaghi also said that while the central bank’s objective of
price stability was necessary for financial stability, it was not
sufficient to achieve financial stabilility.

“Yet there is also no doubt that a monetary policy which turns out
to be too lax to achieve price stability is likely to be responsible for
fuelling excessive credit growth and thereby creating the potential for
financial instability,” he added.

Nevertheless, monetary policy should still remain focused on medium
term price stability, and not be burdened with other objectives for
which it may not be suited, he stressed. It is “too blunt an instrument
to be effective” in properly addressing other goals such as employment
or economic growth as well as price stability, Bini Smaghi said.

“These factors run counter to recent proposals to assign monetary
policy additional financial stability objectives,” he said. “Rather,
maintaining price stability over the medium term — an important
addendum, to which I will return — is the appropriate objective of
monetary policy.”

Bini Smaghi added that a dual mandate for a central bank would
place its independence, which is essential to its credibility, at risk.

“Independence accords central banks the necessary flexibility to
deal with a rapidly changing world without putting their credibility at
risk,” he said.

Furthermore, Bini Smaghi called recent proposals to central banks
to raise their inflation targets “foolhardy”, adding that such actions
would undermine an institution’s credibility.

“Any shift in inflation objectives at times of economic stress
invites the charge of opportunism: if you are willing to raise inflation
objectives from 2% to 4%, then why not 6% or 10%?” he asked
rhetorically.

The central banker also suggested that when such proposals are made
for the sake of public finances, they point to the subordination of
monetary policy to fiscal concerns.

–Frankfurt bureau: +49-69-720 142, email: frankfurt@marketnews.com

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