*** The crisis has reaffirmed the benefits of an independent central bank focused on maintaining price stability and safeguarding well-anchored inflation expectations in line with price stability. The focus on price stability yields gains in credibility and allows central bank flexibility as well as the ability to act decisively when needed on other issues. As an example, let me remind you of the decisive provision of liquidity in August 2007 and later in September 2008. Another example is the decisive policy easing in response to the crisis. The risks of deflation were greatly reduced because inflation expectations over the medium term remained wellanchored, in line with our definition of price stability2. The new spike in energy prices, that reminds us of the spectre of stagflation risks, once again reaffirms how important it is to act decisively to ensure that inflation expectations remain well-anchored to preserve stability. *** Another lesson reaffirmed is that monetary policy is not just about setting policy rates. Even though the academic consensus was converging to this view before the crisis, monetary policy is not just about determining current and future overnight interest rates. As both practical experience and also earlier generations of academics have taught us, there is much more to monetary policy. Prior to the crisis, some were concerned about the zero bound on short-term nominal rates.
Conversely, at the height of the crisis, financial conditions tightened sharply even as the Federal Reserve aggressively pushed its federal funds rate target down toward zero. As a result, monetary policymakers need to take the evolution of financial conditions into consideration. For example, when financial conditions tighten sharply, this may mean that monetary policy may need to be tightened by less or even loosened. On the other hand, when financial conditions ease—as has been the case recently—this can provide additional impetus for the decision to continue to remove monetary policy accommodation. While I agree with Hélène in most respects, there are a few points where I am less convinced. While the global financial cycle complicates policymakers’ ability to guide financial conditions in their own economies, I’m not persuaded that the trilemma has been replaced by a dilemma—that is, essentially an “either/or” choice between an independent monetary policy versus an open capital account. While there is no panacea to insulate countries from financial spillovers—particularly when policy in some areas is constrained by the effective lower bound on interest rates—I think a combination of exchange rate flexibility, a credible monetary policy framework, sufficient foreign exchange reserves, and a strong financial system can help mitigate the effects of such spillovers. Moreover, it strikes me that market participants have become more discriminating over time about the circumstances of different countries, rather than painting all EMEs with a similar broad brush.