Models including these rigidities had greater explanatory power than previous models and were more in line with monetary policy practices at that time. Price stability emerged in both central bank mandates and macroeconomic models as the overriding objective that central banks should pursue in order to maximise social welfare. In the words of an influential article, one could see a “science of monetary policy” developing next to the traditional “art” of monetary policy.3 But there was a notable absence of a role for banking and finance in these models. Wage and price rigidities, together with a few other frictions, appeared to be sufficient to provide a realistic characterisation of the transmission mechanism of monetary policy in the main macroeconomic models. Financial sector developments did not seem to affect this mechanism, because financial intermediation was assumed to be fully efficient. And generally, the interest rates faced by households and businesses typically moved in line with movements in central bank policy rates. True, there were some models that incorporated financial frictions into macroeconomics.4 Central banks themselves were also aware of the role of monetary and financial markets in the monetary policy transmission mechanism. The first Eurosystem Research Network at the ECB studied the so-called bank lending channel, which maintains that banks play a crucial role in the transmission of monetary policy. But the impact of financial frictions was generally estimated to be small in developed countries and these frictions were therefore absent from the canonical models used for monetary policy analysis.

Mario Draghi: The interdependence of research and policymaking Speech by Mr Mario Draghi, President of the European Central Bank, at the Lindau Nobel Laureate Meeting, Lindau, 23 August 2017. * * * I am especially thankful to Professor Hellwig for inviting me to address this conference. All of you Nobel laureates share the extraordinary ability to explain parts of our everyday reality that have not been understood before, or were previously seen from a different, and less informative, perspective. You are the builders of a science that is also a guide to policymaking. Your discoveries have contributed to the way we think, the way we do policy, the way we affect the welfare of millions of individuals. This year marks the 200th anniversary of David Ricardo’s Theory of Comparative Advantage 1 – in the words of Paul Samuelson, one of the few counter-intuitive fundamental ideas in economics, which moved the world away from mercantilism. And when we look at other giants in the history of economic thought, Adam Smith, who laid down the foundations of capitalism; Keynes, who drove us into policy activism and away from laissez-faire; until the founders of econometric model building in post-war time, we cannot but conclude that there is little in economics that does not have policy implications and that the interaction between research and its policy application is continuously evolving in an ever expanding universe. Let me review the most recent development of those interactions and in so doing, I will focus on monetary policy and financial regulation.