In this sense, the recent creation of a Financial Stability Committee in Chile should improve coordination among regulators and have a view on financial stability and risks. Over time, and as learning takes place, some legislation should be introduced in order to enhance the effectiveness of the Committee. In the Central Bank, evaluation of financial vulnerabilities and strengths is performed bi-annually in our Financial Stability Report. Finally, regarding the interactions between macroprudential policies and monetary policy, I would like to make some comments.4 The traditional view has been influenced by the Tinbergen principle, by which there should exist as many instruments as policy targets. This view is reinforced by the fact that, as I argued above, the interest rate is too blunt of an instrument to deal with asset price bubbles and financial dislocations. Therefore, we can think of a separation between the interest rate – the monetary policy instrument to achieve the inflation target – and macroprudential tools to deal with financial stability. 4  See also Bernanke (2011) for discussion on these issues. BIS central bankers’ speeches  5  However, and perhaps unfortunately, the separation is not that clear. As I discussed before, actions of monetary policy, such as the Greenspan put, may create financial instability. The financial crisis also showed that it has effects on the business cycle and, hence, it has implications on monetary policy. Moreover, the transmission channels of monetary policy could be broken down during a crisis.
Thus, the central bank’s inflation forecast at the policy horizon becomes the intermediate target.2 In the case of Chile, our inflation target is three percent, and the time horizon is two years. As long as this target is credible, monetary policy will not only achieve inflation stability, but will also reduce the volatility of the business cycle. Analytically, the FIT regime is based on the idea that the policymaker minimizes a loss function that penalizes both inflation deviations from the target and deviations of output from full employment. Therefore, what the FIT does is to optimize the tradeoff between output  1  A predecessor was Taylor (1998) who called this period the “long boom.”  2  In order to avoid indeterminacy or multiple equilibria, the forecast must be the central bank’s forecast and not that of the market (Bernanke and Woodford, 1997). 2  BIS central bankers’ speeches  volatility and inflation volatility. The time horizon is what makes this scheme “flexible.” The target is not achieved in the short run since it also takes the output costs of achieving the target into account. A rigid inflation target is one in which the central bank only cares about inflation, and hence the horizon would be the shortest possible, enough for monetary policy to affect output. The longer the time horizon, the higher the weight of output volatility in the loss function (De Gregorio, 2007).