14  Nyberg (2010) provides more discussion of macroprudential regulation and regulation reform. BIS Review 16/2010  7  significant social costs. I find it helpful to conceptually distinguish financial-stability policy from monetary policy. Different economic policies and policy areas, such as fiscal policy, labor market policy, structural policies to improve competition, etc., can be distinguished according to their objectives, the policy instruments that are suitable for achieving the objectives, and the authority or authorities controlling the instruments and responsible for achieving the objectives. Monetary policy in the form of flexible inflation targeting has the objective of stabilizing both inflation around the inflation target and resource utilization around a normal level. The suitable instruments are under normal circumstances the policy rate and communication, including possibly a published policy-rate path and a forecast of inflation and the real economy. In times of crisis, as we have seen during the current crisis, other more unconventional instruments can be used, such as fixed-rate lending at longer maturities, asset purchases and foreign-exchange intervention to prevent currency appreciation. The authority responsible for monetary policy is typically the central bank. Financial-stability policy has the objective of maintaining or promoting financial stability. The available instruments are under normal circumstances supervision, regulation and financialstability reports with analyses and leading indicators that may provide early warnings of stability threats. In times of crisis, there are instruments such as lending of last resort, variable-rate lending at longer maturities, special resolution regimes for financial firms in trouble, government capital injections and so forth.

Another conclusion is that interest-rate policy is not enough to achieve financial stability. Other instruments like supervision and regulation, including appropriate bank resolution regimes, should be the first choice for financial stability. In many countries, the responsibility for these instruments rests on authorities other than the central bank. Generally, to the extent financial instability depends on specific distortions, good regulation should aim to attack these distortions as close to the source as possible. To counter the observed procyclicality of existing regulation, macro-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. As expressed by Bean (2009), “the best approach is likely to involve a portfolio of instruments”. 14 More generally, what is the relation between financial stability and monetary policy? Financial stability is an important objective of economic policy. A possible definition of financial stability is a situation when the financial system can fulfil its main functions (of submitting payments, channelling saving into investment and providing risk sharing) without disturbances that have  12  Kohn (2008), after extensive discussion, concludes that there is insufficient evidence that low interest rates would have contributed much to the house-price boom and that higher interest rates would have had much dampening effect on it. 13  The relationship for the Euro area countries is less weak, but for reasons explained by Bernanke (2010) it is potentially overstated.