Financial Instability and Monetary Policy: An Interaction with Institutional Quality

Certainly, financial instability has a negative effect on real sphere, that's why many studies had tried to identify the origins of financial crisis that had shaken developing countries. Monetary and real factors were considered as explicative factors of financial crisis. Moreover, monetary policy represents an obvious explication of financial instability, but it can never be considered as the only determinant of financial crisis. In fact, its determinism is dependant on institutional quality. The conduct of an expansive monetary policy has a negative effect on financial stability since it induces an increase of inflation. Nevertheless, a restrictive monetary policy can't represent a guarantee against financial instability as it causes financial unbalances and monetary distortions that take the form of credit boom. In consequence, it would be interesting to give much importance to institutional quality since the conduct of an expansive or restrictive monetary policy depends on the institutional environment where monetary authorities intervene. We apply a Panel data model to a sample of developing countries on the period (1990–2007) in order to verify that the effect of monetary distortions on financial stability is tributary of institutional quality.