Many of the effects associated with financial and asset price imbalances are likely to be highly non-linear and complex. The reaction of monetary policy should then also be non-linear and it should respond to asset price misalignments and financial imbalances. When the probability of a crisis becomes non-trivial, the interest rate path towards ensuring monetary stability might be different than in ordinary circumstances.
These aspects were not well captured in the empirical models used to support monetary policy decisions, something understood but perhaps not adequately recognized in discussions on flexible inflation targeting frameworks that took place a decade or so ago.9 One of my preferred quotes is from Herbert Simon:10 Good predictions have two requisites that are often hard to come by.