2  BIS Review 118/2010  prudential regulation that is contingent on the business cycle and financial indicators may need to be introduced to induce better financial stability. Possible macro-prudential regulation includes variable capital, margin, and equity/loan requirements. However, one important lesson from the financial crisis is that financial conditions may have a very strong and deteriorating effect on the transmission mechanism, making standard interest-rate policy much less effective. This motivates more research on how to incorporate financial conditions and financial intermediation into the standard models of the transmission mechanism used by central banks. Much progress has already been made in understanding these effects (see Adrian and Shin 2010, Gertler and Kiyotaki 2010 and Woodford 2010a). However, even with much better analytical foundations concerning the role of financial conditions in the transmission mechanism, there will of course, as always, be considerable scope for the application of good judgment in monetary policy. What about “leaning against the wind”, the idea that central banks should raise the interest rate more than what appears to be warranted by inflation and resource utilisation to counter rapid credit growth and rising asset prices? It has sometimes not been entirely clear to me whether advocates of the leaning against the wind policy mean that credit growth and asset prices should be considered targets and entered into the explicit or implicit loss functions alongside inflation and resource utilisation.

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