But this would not mean that financial conditions and indicators would become independent targets for monetary policy. Conclusions My main conclusion from the crisis with regard to monetary policy so far is that flexible inflation targeting – applied in the right way and using all the information about financial conditions that is relevant for the forecast of inflation and resource utilisation at any horizon – remains the best-practice monetary policy before, during, and after the financial crisis. But a better theoretical, empirical and operational understanding of the role of financial conditions and financial intermediation in the transmission mechanism is urgently required and needs much work, work that is already underway in academia and in central banks. Furthermore, monetary policy cannot guarantee financial stability. A separate financial-stability policy, with the objective of financial stability and with suitable instruments other than the policy rate, is required. References Adrian, Tobias, and Hyun Song Shin (2010), “Financial Intermediaries and Monetary Economics,” in Friedman, Benjamin M., and Michael Woodford (eds. ), Handbook of Monetary Economics, Volume 3, Elsevier, forthcoming. Adrian, Tobias, and Hyun Song Shin (forthcoming), “Liquidity and Leverage,” Journal of Financial Intermediation, available as Federal Reserve Bank of New York Staff Reports 328, 2007. Assenmacher-Wesche, Karin, and Stefan Gerlach (2009), “Financial Structure and the Impact of Monetary Policy on Asset Prices”, working paper, www.stefangerlach.com. Bernanke, Ben S. (2007), “Global Imbalances: Recent Developments and Prospects,” speech on 11 September 2007, www.federalreserve.gov. Bernanke, Ben S. (2010), “Monetary Policy and the Housing Bubble”, speech on 3 January, 2010, www.federalreserve.gov.
Another conclusion is that interest-rate policy is not enough to achieve financial stability. The policy rate is an ineffective instrument for influencing financial stability, and policy rates high enough to have a noticeable effect on credit growth and house prices will have a strong negative effect on inflation and resource utilisation, even in sectors that are not experiencing any speculative activity. The use of the policy rate to prevent an unsustainable boom in house prices and credit growth poses major problems for the timely identification of such an unsustainable development, as well as for the assessment of whether policy-rate adjustment would have any noticeable impact on the development, and of whether, in the longer run, the development of inflation and resource utilisation would be better (Bean et al. 2010, Kohn 2008, 2009). Other instruments like supervision and regulation, including appropriate bank resolution regimes, should be the first choice for financial stability. Preventing a financial crisis requires not only improvements in the supervision of financial institutions, but also a greater emphasis on the supervision of the financial system as a whole. As regards the regulatory framework, generally, to the extent that financial instability depends on specific distortions, good regulation should aim to attack these distortions as close to the source as possible. Macro-  3  See Svensson (2003) for a discussion of policy options before and in a liquidity trap. 4  See Assenmacher-Wesche and Gerlach (2009), Bean (2009), Bean et al. (2010), Bernanke (2010), Dokko et al. (2009), IMF (2009).