conclusion is that consideration of the impact of financial factors on the forecast of inflation and resource utilization may require longer forecast horizons. several inflation - targeting central banks ( including the bank of england, norges bank and the riksbank ) have for other reasons already extended their forecast horizon from the previously common two years to three years. there is nothing that in principle prevents an inflation targeter from considering forecasts beyond a three - year horizon, but in practice there is usually little information about anything at longer horizons except the tendency to revert to the long - term average. what about “ leaning against the wind ” ( as advocated by, for instance, borio and white, 2003, and cecchetti, genberg and wadhwani, 2002 ), the idea that central banks should raise the interest rate more than what appears to be warranted by inflation and resource utilization to counter rapid credit growth and rising asset prices? it has sometimes not been quite clear whether advocates of leaning against the wind mean that credit growth and asset prices should be considered targets and enter the explicit or implicit loss functions alongside inflation and resource utilization, or whether they mean that credit growth and asset prices should still be considered just indicators and are emphasized only because credit growth and asset prices may have potential negative effects on inflation and resource utilization at a longer horizon. in the latter case, leaning against the wind is a way to improve the stability of inflation and resource utilization in the longer run. then it is completely consistent with flexible inflation targeting. however, in line with the previous discussion, other instruments than interest rates are likely to be much more effective in avoiding excessive credit growth and asset - price booms, since interest rates that are high enough to have a noticeable effect on credit growth and asset prices may have strong negative effects on inflation and resource utilization, and a central bank will probably rarely have sufficient information about the likely beneficial longer - horizon effects on inflation and resource utilization for the trade - off to be worthwhile and motivated. 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 in the standard models of the transmission mechanism used by central banks, and 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 questions include how potential output and neutral real

path so that the forecast of inflation and resource utilization “ looks good. ” by a forecast that looks good i mean a forecast either in which inflation is already on target and resource utilization is already normal, or in which inflation is approaching the target and resource utilization is approaching a normal level at an appropriate pace. more precisely, it means a forecast for inflation and resource utilization that as effectively as possible stabilizes inflation around the inflation target and resource utilization around its normal level. in the event of conflicting objectives, it achieves a reasonable compromise between the stability of inflation and the stability of resource utilization. 1 different central banks express this in slightly different words. the riksbank has often used the term “ well - balanced ” monetary policy. 2 the forecasts of inflation and the real economy are then conditional on the central bank ’ s view of the transmission mechanism, an estimate of the current state of the economy and a forecast of important exogenous variables. the central bank uses all relevant information that has an impact on the forecast of inflation and the real economy. in this framework, the central bank takes financial conditions such as credit growth, asset prices, imbalances, potential bubbles and so on into account only to the extent that they have an impact on the forecast of inflation and resource utilization. inflation and resource utilization are target variables here, that is, variables that are arguments of the central bank ’ s loss function. hence, financial conditions are not target variables. instead, they are only indicators, as they provide information about the state of the economy, the transmission mechanism and exogenous shocks to the central bank. financial conditions then affect policy rates only to the extent that they have an impact on the forecast of inflation and resource utilization. 3 3. financial stability as a rarely binding constraint – a pre - crisis view what is the role of financial stability in a pre - crisis view of flexible inflation targeting? maintaining financial stability, including a well - functioning payment system, is, explicitly or implicitly, an important objective for central banks. in my overview of best - practice monetary policy in svensson ( 2002 ), long before the crisis but during an ongoing debate about monetary policy and asset prices, i briefly discussed how this objective can be reconciled with flexible inflation targeting, how conflicts can arise and how they could be handled. 4 one question is whether financial stability belongs in the loss function for the central bank, together with inflation and resource utilization. i argued that a good way of handling this additional objective is