As is well known, the long lags of policy creates a need for central banks to “take the punch bowl away when the party gets going”. Given the longer duration of financial cycles, the need to act well before the risks become obvious may mean that central banks will have to “take the punch bowl away even before the party gets started”. But that is a political economy challenge that needs to be resolved and managed through careful redesign of central bank mandates. Heed must be paid also to institutional arrangements, especially for central banks where the financial supervision authority lies with another body as coordination will be harder. This will take time. But the risks to financial stability is immediate. In the interim, central banks may need to interpret their mandates more flexibly and avoid overly narrow and zealous interpretations of price stability. Inflation targets need to be implemented flexibly and over longer horizons. All the while explaining clearly and consistently the logic of policy. In doing so, it should be stressed that fundamentally, macroeconomic and financial stability are two sides of the same coin. Macroeconomic trajectories cannot be sustainable 9  if the financial sphere is out of equilibrium. And the avoidance of financial boom-bust cycles leads to better economic outcomes over the long run. The perceived trade-off between growth, inflation, and financial stability, therefore, is to a large extent an artifact of the short horizon focus of policy.

More broadly, the underlying institutional and legal frameworks that govern financial markets must be taken into account. These include financial product regulations, deposit guarantee systems, as well as the resolution framework for troubled financial institutions. A national financial stability framework that brings together and assesses the whole spectrum of financial regulation serves this important function. The second response to the more complex monetary trade-off is greater policy coordination. The underlying rationale for coordination is that in certain situations, the collective outcome of central banks acting individually according to their mandates may be inferior because cross-country spillovers are not internalized. The current aggressive monetary easing of advanced economies are a case in point. Whether intended or simply a by-product, the outcome has the semblance of competitive devaluations. 7  As a starting point, it is important that advanced economies acknowledge the potential spillovers of their policy. The Federal Reserve, in particular, wields outsized influence given the dominance of the US dollar in global trade and finance. Emerging market countries need to coordinate in voicing their concerns and engage in dialogue. At a minimum, consultation minimizes surprises and the exchange of views helps to narrow differences in perceptions. But there is a more implicit form of coordination that I believe holds much potential. That is the coordination of monetary policy frameworks. This brings me to the third and perhaps most profound avenue for dealing with the new monetary policy trade-off. And that is the adoption of a monetary policy framework that systematically takes financial stability into account.