Price Stability, Financial Stability and Central Bank Effectiveness: A Common‐Agency Perspective

ABSTRACT This article considers the institutional design of monetary policy and the trade‐offs faced by central banks when they try to tackle both price and financial stability at the same time. The complementarity between monetary and macroprudential policies has been highlighted in terms of objectives and operational implementation, the ‘divine coincidence’. Nevertheless, the assignment of both mandates to the same institution has not remained unchallenged. While the literature typically assumes homogeneous preferences of the public/society, in this article we introduce agency considerations, reflecting heterogeneous preferences of policymakers and the public. We adopt a common‐agency framework, accounting for formal central bank mandates along with external pressure on monetary policy, to analyse under which conditions it is optimal to assign price and financial stability mandates to one or two separate institutions. Our results show that the ability to achieve a set of given monetary and financial stability targets does not depend on the number of tasks an institution is assigned, but on the degree of independence of the institution itself.