Finally, the recent experience has shown that the costs associated with the bursting of an asset price bubble can be simply staggering, and that monetary policy cannot be reasonably expected to completely shield the economy from the aftershocks. In particular, research spurred by the crisis – pursued, first and foremost, by Reinhart and Rogoff10 – has shown that, historically, the bursting of asset price bubbles has been associated, most of the time, with deep recessions, slow and drawn-out recoveries, large budget deficits and dramatic build-ups of national debt. II.3. The (supposedly) encompassing role of inflation forecasts  Let me now turn to a third lesson of the crisis, that is, the supposedly encompassing role of inflation forecasts. The dominant presumption among inflation-targeting central banks during the period leading up to the crisis was that the central inflation projection at the desired horizon (typically, two years ahead) represents a sufficient statistic for monetary policy, in the specific sense of encoding all the information which is relevant for its conduct. This position had two logical corollaries: (i) interest rates should be moved in order to bring the central inflation projection in line with the inflation objective at the desired horizon; and (ii) they should react to asset price movements only to the extent that such movements impact upon the inflation projection at the relevant horizon. An important point to stress is that this presumption was never subscribed to within the Euro area.
The new framework will feature two objectives – price and financial stability – which, based on standard economic analysis, means that we will need two separate set of instruments to achieve them. Further, based again on standard analysis, the assignment of instruments to objectives ought to be based on the principle of comparative efficiency: monetary policy is the natural instrument for pursuing price stability, whereas macroprudential policies – defined as a set of policies aimed at limiting both excessive credit growth and the build-up of systemic risk within the financial system – will have to take care of preserving financial stability. II.2. Monetary policy and financial stability  During the years leading up to the crisis, the dominant doctrine was that monetary policy should not attempt to lean against bubbles as they inflate by raising interest rates, and it should rather only “mop up” the consequences of their eventual bursting by cutting rates aggressively. There were three main rationales behind such a position. First, it was argued, it is impossible for central banks to identify a bubble in real time: if it were possible, markets would have identified it too, and the bubble would not have developed in the first place since central banks have access to the very same information as market participants. To be sure, this argument did not go unchallenged.