In the event of conflicting objectives, it achieves a reasonable compromise between the stability of inflation and the stability of resource  BIS Review 112/2009  1  utilization. 1 Different central banks express this in slightly different words. The Riksbank has often used the term “well-balanced” monetary policy. 2 The forecasts of inflation and the real economy are then conditional on the central bank’s view of the transmission mechanism, an estimate of the current state of the economy and a forecast of important exogenous variables. The central bank uses all relevant information that has an impact on the forecast of inflation and the real economy. In this framework, the central bank takes financial conditions such as credit growth, asset prices, imbalances, potential bubbles and so on into account only to the extent that they have an impact on the forecast of inflation and resource utilization. Inflation and resource utilization are target variables here, that is, variables that are arguments of the central bank’s loss function. Hence, financial conditions are not target variables. Instead, they are only indicators, as they provide information about the state of the economy, the transmission mechanism and exogenous shocks to the central bank. Financial conditions then affect policy rates only to the extent that they have an impact on the forecast of inflation and resource utilization. 3 3. Financial stability as a rarely binding constraint – a pre-crisis view  What is the role of financial stability in a pre-crisis view of flexible inflation targeting?
At the same time, concerns about the possible problems for the financial market apparently made the Bank of England decide to go no lower than 50 basis points and initially, in April 2009, prevented the Riksbank from going below 50 basis points, although the Riksbank later in July lowered the policy rate to 25 basis points. 5 How does the central bank know whether the constraint binds or not? I thought that it would know by continually monitoring the state of the financial sector. In some countries, the central bank publishes a regular Financial Stability Report of the type pioneered by the Bank of England and the Riksbank. These reports include an analysis of indicators of the state of the financial sector, in particular early-warning indicators of potential future problems. They serve to assure the general public and economic agents that everything is well in the financial sector when this is the case. They also serve as early warnings of the agents' concerns and for the financial-regulation authorities when problems show up on the horizon. Early action could then prevent any financial instability from materializing, thus limiting the probability of future threats to financial stability and future binding constraints on monetary policy.