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Capital Regulation And Monetary Policy With Fragile Banks

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Executive Summary

The financial crisis is producing, among other consequences, a change in perception on the roles of financial regulation and monetary policy. The pre-crisis common wisdom sounded roughly like this. Capital requirements and other prudential instruments were supposed to ensure, at least with high probability, the solvency of individual banks, with the implicit tenet that stable banks would automatically translate into a stable financial system. On the other side, monetary policy should largely disregard financial matters and concentrate on pursuing price stability (a low and stable consumer price inflation) over some appropriate time horizon.

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