Ultimately, my main conclusion from the crisis so far is that flexible inflation targeting, applied in the right way and using all the information about financial factors that is relevant for the forecast of inflation and resource utilization at any horizon, remains the best-practice monetary policy before, during, and after the financial crisis. But a better theoretical, empirical and operational understanding of the role of financial factors in the transmission mechanism is urgently required and needs much work, work that is already underway in academia and in central banks. The outcome might very well be that financial factors are considered to have a larger role in affecting the transmission mechanism and as indicators of future inflation and resource utilization. If so, central banks would end up responding more to financial indicators, in the sense of adjusting the policy rate and policy-rate path more to a given change in a financial indicator. However, this would not mean that financial factors and indicators have become independent targets besides inflation and resource utilization in the explicit or implicit centralbank loss function. Instead, it would be a matter of responding appropriately to financial indicators in order to achieve the best possible stabilization of inflation around the inflation target and resource utilization around a normal level over time. References Adrian, Tobias and Hyun Song Shin (2007) “Liquidity and Leverage”, Journal of Financial Intermediation, forthcoming. Available as Federal Reserve Bank of New York Staff Reports 328.

One important lesson from the financial crisis is that financial factors 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 factors into the standard models of the transmission mechanism used by central banks. A rapidly-increasing volume of such research is now being produced by academic and central-bank researchers and presented at an increasing number of conferences on financial factors and monetary policy. Important and challenging questions include how potential output and neutral real interest rates are affected by financial factors and financial distortions (Curdia and Woodford 2009, Walsh 2009), and  15  However, conceptually distinguishing the two policy areas does not rule out that there might be advantages of to keeping a large part of the responsibility for financial-stability policy within the central bank, as argued by, for instance, Blinder (2010) and Nyberg (2010). 8  BIS Review 16/2010  what impact financial factors have on the general equilibrium effects of alternative policy-rate paths on inflation and resource utilization forecasts. 16 Even with much better analytical foundations concerning the role of financial factors in the transmission mechanism, there will of course, as always, be considerable scope for the application of good judgment in monetary policy. Another conclusion, which is not new, is that consideration of the impact of financial factors on the forecast of inflation and resource utilization may require longer forecast horizons.