Abstract

Financial Innovations, Monetary Policy and Financial Stability

This paper reviews the main trends in the broad field of financial innovations, as these came about in the major industrial countries since the mid-seventies. First of all attention is given to the characteristics and activities of the financial intermediaries on financial markets and to the shifting frontiers between the different kinds of financial institutions. Subsequently the causes and driving forces of financial innovations are analyzed (deregulation of financial markets, monetary uncertainties, internationalisation of financial markets, information-technology etc.). In the next section an outline is given of the phenomena of disintermediation, securitisation and offbalance sheet activities, which refer to the increasing trend in the marketisation of banking and finance. The pace of financial innovations and the associated changes in the working of financial markets have important consequences for the design and the implementation of monetary policy. In this context attention is given to the operational meaning of the traditional money-definition, to the influence of the current wave of innovations on the money-supply process, on the stability of the moneydemand function and on the transmission channels ofmonetary policy. It appears that as a result of the globalisation of financial markets in the recent past the exchange rate has taken on greater importance in the transmission processes of monetary policy impulses, especially in small open economies. Finally, some remarks are made on the task of central banks, the supervisory authorities, to safeguard the stability and soundness of the whole financial system. In this context there is a growing need for coordination and harmonization of banking supervision in the world.