4  BIS central bankers’ speeches  Existing models, then, do not tell us why stability today may come at the expense of instability tomorrow. Perhaps we should heed the advice of Ricardo Caballero, who has written that “macroeconomic research has been in ‘fine-tuning’ mode within the local maximum of the dynamic stochastic general equilibrium world, when we should be in ‘broad-exploration’ mode”. 14 So let me now move into broad exploration mode and give three examples in which a trade-off between monetary and financial stability might arise, and which could in theory justify a policy of aiming off the inflation target in order to reduce the risk of future financial instability, before I turn to whether such a policy would have been appropriate before the crisis. The first is where misperceptions about future incomes persist and are embodied in key prices, such as the exchange rate and long-term interest rates. Households, businesses, and banks can all make big mistakes when forming judgements about the future, and make spending decisions today which they will come to regret when their true lifetime budget constraints are revealed. There is no mechanism for ensuring that misperceptions about the sustainable level of spending are corrected quickly. It may take many years before those beliefs are invalidated by experience. So an equilibrium pattern of spending and saving can emerge that is stable temporarily but not sustainable indefinitely. And misaligned prices may reinforce mistaken beliefs if people are using market prices to extract signals about future incomes and consumption opportunities.
First, it led to bank supervision becoming the responsibility of an increasing number of central banks. Second, the focus on systemic stability led to the emergence of macroprudential supervision as an explicit concept and task for which naturally central banks have become responsible. In Bulgaria the monetary regime can be viewed as a rather traditional one, the primary objective of the BNB being to maintain price stability through ensuring the stability of the national currency. For more than 20 years now, our regime has been based on the operation of the currency board. The BNB also conducts micro- and macroprudential policies. As a matter of fact, well before the recent global crisis we designed and applied countercyclical macroprudential measures, even though the term ‘macroprudential’ was still not being used. Many other countries in the region, subject to massive capital inflows at the time, did the same. Therefore, the BNB’s tasks and responsibilities, as we see them today, are an outcome of decades of evolution. And this reflects, and is consistent with, the long-term developments of central banks’ mandates globally. It can be argued from a historical perspective that changes in these mandates follow common evolutionary paths which are often shaped by crises, such as the global one in 2007/2008. The financial stability focus That led to reassessing the importance of financial stability as a policy objective of central banks. Before the 2007/2008 global crisis, central banks focused on price stability as their primary objective.