##ification is advisable under certain circumstances, but more realistic models for expectation formation may be useful in other respects. several papers at this conference pay tribute to this fact. le me just mention monika piazzesi's paper. modifying the assumptions about the expectations formation process or introducing model uncertainty has important consequences for economic policy - and monetary policy in particular - as has been highlighted several times at this conference. in this respect i should like to mention the contributions by lars hansen as well as by lars svensson and noah williams. both, “ robust control ” or “ distribution forecast targeting ” methods are designed to deal with model uncertainty. a second, and often related topic, is our still very incomplete knowledge of how financial markets work and how they deal with the problem of limited information. several papers at this conference illustrate the role of collateral and the problems we are confronted with if this instrument is not available. let me mention as one example the paper by larry christiano and his co authors. this paper points out the fundamental role which collateral plays in an integrated world and concludes that " having collateral or having not " not only makes a big difference for the creditors and debtors but also for monetary policy. however collateral might play different roles in different financial systems. john moore ` s paper is very informative in this respect. it is in my view also interesting because it improves our understanding of the linkage between developments in the financial system and in the real economy. chris sims in his paper on " rational inattention " makes another point : our limited ability to collect information may have far reaching consequences for our models. 3. modelling financial system behaviour ladies and gentlemen macro - modelling of financial market developments, let alone financial stability has by most measures less progressed than general macroeconomic modelling. at least four reasons for that are obvious : • firstly, financial integration on a regional as well as on a global scale mostly followed real integration ( trade induced financial flows ). • secondly, the role of expectations and psychological aspects seems to be much more pronounced on financial markets. neither is very easy to capture analytically or to quantify. • thirdly, the financial system became much more complex in a short period of time as a result of a number of significant structural changes. • finally, proper modelling of financial markets in a general equilibrium context has to confront the issues of incomplete markets and heterogeneous agents in a much more direct way than most of the traditional macro models do. see clarida,

tried to tackle this puzzle. the distinguishing feature of his paper is the fact that the allocation of risk across households is assumed to be socially optimal. this has implications for the interpretation of high returns in equity markets. all these new findings may help us to make progress in understanding financial markets and in finding a better theoretical framework to discuss financial stability. in this context, let me briefly reflect on whether or not financial stability should be an explicit central bank objective in line with its other objectives. the additional objective of financial stability is explicitly enshrined in many central bank charters. however, the question of how policymakers are to weigh the various objectives against each other is one that so far remains unsettled. 10 an undisputed case is the monetary policy reaction to financial instabilities that are significant enough to cause estimated good price inflation to deviate significantly from target. in this case no conflict arises. there also seems to be agreement on the rapid and resolute use of monetary policy in the case of extreme events which could threaten financial stability. 11 see gjedem, svein ( 2005 ), the macroprudential approach to financial stability, keynote address at the conference “ monetary policy and financial stability ” hosted by the oesterrreichische nationalbank, vienna, may 12, 2005 ; published : see ferguson, roger w. ( 2002 ), should financial stability be an explicit central bank objective? paper presented to an international monetary fund conference on challenges to central banking from globalized financial markets, washington, d. c., september 17, 2002. see gjedem, svein ( 2005 ), the macroprudential approach to financial stability, keynote address at the conference “ monetary policy and financial stability ” hosted by the oesterrreichische nationalbank, vienna, may 12, 2005 ; published : however, other cases are conceivable. think about evolving financial imbalances over a long period of time. how can and how should central banks react? the debate on “ asset prices and monetary policy ” remains open. in his dinner speech yesterday vice chairman roger w. ferguson discussed that issue. taking this one step further, there is the question of how to react in a financial crisis. as lawrence christiano et al have demonstrated, we need to construct more realistic general equilibrium models in the context of financial turbulence. i have already referred to two key elements these models should entail : heterogeneous agents and incomplete markets. charles god