This reassessment, therefore, is important and will provide a useful starting point for a better deliberation of monetary policy going forward. For this morning, I want to focus my remarks on three issues: first the lessons we can learn from the crisis; second how to move forward to strengthen monetary policy framework in light of the crisis to ensure long-term price and financial stability; and third the relevance of inflation-targeting as a monetary policy framework in the post-crisis era. From the crisis, there are a number of important lessons that can be drawn. The first is that monetary policy remains the right instrument to maintain a low inflation environment which is crucial for sustainable growth. But the most important lesson from the crisis is that low and stable inflation alone is not sufficient for ensuring financial stability. This is because the risk to financial stability can come from many sources other than domestic inflation. In the current crisis, it was the housing bubble and excessive risk-taking by the financial institutions that precipitated the crisis in the environment of stable prices. Therefore, to maintain economic and financial stability, in addition to price stability, attention must be paid to all the key sources of risk and imbalance that can have systemic implications for the economy’s growth and stability. This is the first lesson. The second lesson is the inadequacy of the current approach in monetary policy analysis that focuses over-extensively on macroeconomic analysis and models.
However, there is a concern that this approach is judgemental and lacks a coherent framework; i.e., how can we control both the price of credit through monetary policy and the quantity of credit through macroprudential measures. Another unsettling issue is whether monetary policy should lean against the wind of asset price boom and credit expansion at a cost of somewhat weaker growth and lower inflation. On this, I think our default position should be that we should because the cost of getting it wrong by not doing enough can be very costly. Finally, information on money and credit aggregates can be made more useful in the formulation of monetary policy. Up to now, a widely shared so-called “best practice” in monetary policy did not pay enough attention to monetary aggregates partly because of the belief that there exists no stable relationship between quantity of money and economic activity. As a result, prior to the crisis there was no attempt to counteract the rapid credit  2  BIS Review 8/2010  growth even though, in most if not all cases, asset price bubble was a direct result of sustained excessive credit expansion. This issue in my view is most relevant for emerging markets where the financial sector is typically bank-based, with credit being the major source of funding for businesses, and credit risk being the most important risk to banks. Such factors make the credit channel an important transmission mechanism of monetary policy in emerging markets.