price stability in the medium - run. the new culture would also focus on decision - making under uncertainty. second, central banks either need a shift in their monetary policy framework to deal explicitly with financial imbalances, or interpret their current framework in a way that gives them more freedom in pro - actively trying to avoid that financial imbalances burst, with major macroeconomic consequences. one approach would be to keep a mandate of price stability – that is not introduce financial stability or asset prices as a second goal for monetary policy – but follow a two - track approach to monetary policy. the first track would be a sufficient guide of action when no imbalances accumulate. under these conditions, the “ traditional ” monetary policy could be followed. the second track would focus on monitoring the build - up of stocks ( for example the debt to gdp ratio ) and associated potential macro - risks ( in particular risks for price stability ) in the medium - run. this approach would require greater flexibility, since at times the policy rate could be changed even if inflation looks perfectly anchored. it would also require a horizon longer than two years, since the cycle of accumulation and unwinding of imbalances typically draws out further than two years. greater flexibility and a longer horizon imply a more challenging role for communication. how should we communicate a tightening of monetary policy when inflation is low but there are some concerns that financial imbalances are accumulating, which have a very small chance of unwinding in a very disruptive way five years ahead? another important ingredient of this approach is the close coordination, both with supervisory authorities and, once a crisis erupts, with fiscal authorities. do central banks need to abandon their current monetary framework to follow the approach i have outlined? i believe not. in practice, both the ecb ’ s second pillar and the bank of japan ’ s long - term perspective can lend themselves to – and in fact already capture elements of – this new approach. the same might be true for a flexible inflation targeting framework as it is currently followed by the reserve bank of australia. i hope that the academic scholars, policymakers and market participants that are joining us today for this workshop, will help us gain further insights into these important issues.

elements can have catastrophic consequences and to act upon this recognition. why did monetary policy not lean against the wind? in the past, i have stated that “ many of the risks that crystallised in the past year were on our radar screen long before the crisis started ”. 1 at the same time, i argued that these risk nout wellink ( 2008 ) “ it ’ s the incentive, stupid! ” speech at the conference on “ integrating micro and macroeconomic perspectives on financial stability ”, university of groningen, 26 may 2008. assessments were not translated into an efficacious preventive action – at least not by monetary authorities. but why did we not lean against the wind? i believe that this happened for five main reasons. 1. first, there was an inability – by both academic researchers and analysts in the policymaking world – to pay sufficient attention to the role of stocks. in 2007, high levels of debt had resulted from a prolonged period of strong credit growth and excessive risk - taking. these made the economy vulnerable to negative shocks, such as the collapse of the us subprime mortgage market. the importance of the stock of debt in the lead - up to the crisis is a manifestation of a more general phenomenon, whereby in a context of disequilibrium – such as the accumulation of financial imbalances – stocks dominate flows as determinants of macroeconomic dynamics. this phenomenon cannot be captured in standard macroeconomic models based on linear relationships. in tranquil times, the relevance of stocks is modest, and flows as well as prices of flows matter. under these circumstances, policy is about fine tuning – mostly through the anchoring of expectations. however, “ ordinary ” monetary policy that is based on flows ( monetary flows ) and prices ( inflation ) cannot deal with the implications of stocks that are typical of periods in which massive financial imbalances can accumulate. we now know that looking after stocks is necessary during good times as a means to prevent financial crises. 2. second, macroeconomics and policymaking have focused on decision - making in conditions of measurable risk, rather than immeasurable risk or what is known as knightian uncertainty. the concept of measurable risk may be appropriate during “ normal ” times. but when we face a build - up of massive financial imbalances, it is impossible to measure risks correctly because, like keynes said, “ we simply do not know ” the future. the crisis has taught us that there are always