The resource-utilisation and inflation forecasts will fall below a sustainable level and the inflation target, respectively. The appropriate monetary-policy response under flexible inflation targeting is to lower the policy rate and the policy-rate path. This will stimulate the economy, moderate the nominal and real appreciation, and shift up the forecasts of inflation and resource utilisation towards the target and a sustainable level, respectively. In the new equilibrium, the currency has appreciated somewhat in real terms, the nominal and real interest rate will be lower, the tradable-goods sector may have contracted somewhat, and the nontradable-goods sector may have expanded somewhat. This is the monetary-policy response that I vote for when this situation arises for Sweden. Suppose that for some reason the central bank is not willing to accept the nominal and real appreciation of the currency. By lowering the domestic interest rate and the policy-rate path so as to keep the interest-rate differential and its forecast unchanged, the central bank could in principle maintain a fixed exchange rate and zero capital flow. But the lower nominal and real interest-rate paths are expansionary, and the inflation and resource-utilisation forecasts will shift up, above the inflation target and a sustainable level, respectively. The domestic economy is effectively importing the foreign economy’s monetary policy, which is too expansionary for the domestic economy. The increased growth and activity and the expectation that the central bank may eventually have to accept an appreciation may then still lead to a capital inflow, even though the interest-rate differential is unchanged.

My conclusions are as follows: The crisis was not caused by monetary policy but by other factors, mainly regulatory and supervisory failures in combination with some special circumstances, such as low real interest rates due to global imbalances and U.S. housing and housing-financing policy. Easy monetary policy in the United States did not cause the crisis. A lesson from the crisis is that price stability is not enough to achieve financial stability. But, importantly, interest-rate policy is not enough to achieve financial stability. A separate financial-stability policy is needed for financial stability. Given this, flexible inflation targeting – applied in the right way and using all the information that is relevant for the forecast of inflation and resource utilisation, including the conduct of financial-stability policy when appropriate – remains in my view the best-practice monetary policy before, during, and after the financial crisis. It was financial-stability policy that failed and caused the crisis, and that needs to be improved, not monetary policy. When setting up a better financial-stability policy, it is important to understand that monetary policy is distinct and different from financial-stability policy. The two policies have different objectives and different suitable instruments. Furthermore, the responsibility for monetary policy and control of the monetary-policy instruments rests with the central bank, but the responsibility for financial-stability policy and control of the financial-stability instruments are in most countries shared between several authorities. It is important to conceptually distinguish financial-stability policy from monetary policy and avoid conceptual and practical confusion between the two policies.