This can be easily seen in monetary policy, where no mechanistic use of forecasting models can be made if one allows for the possibility of structural changes.8 An important lesson of the financial crisis – one that is generating substantial research activity – is that the interactions and feedbacks between the real and the financial sectors and the non-linearities that emerge especially during crises are not adequately captured by the available models.
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.