Key rate as a tool to prevent financial instability based on market expectations

Abstract

Subject. This article analyzes the relationship between financial stability and the central bank rate. Objectives. The article aims to justify the tightening of monetary policy based on the yield curve in anticipation of financial instability in financial markets. Methods. For the study, I used statistical, regression, and graphical analyses. Results. Estimates of binary models and the graphical method show a significant impact of yield curve inversion on the probability of a crisis during shocks. The article finds that it is appropriate to raise rates to ensure financial stability during the period of yield curve inversion. Conclusions. Ultra-soft monetary policy and its tightening carry risks to financial stability, stimulate vulnerabilities such as rising or falling asset prices and risk acceptance by market participants. Policy tightening should be based on market expectations and with preliminary stress testing of the banking sector for interest rate risk. This will ensure financial stability and maintain an emphasis on price stability. The results can be useful to central banks in the face of uncertainty and in the run-up to financial instability.