. to sum up, i believe that the recent financial crisis has not challenged the principle according to which the goal of monetary policy should be price stability. in practice, this is recognised see : e. g. s. s. roach ( 2010 ). “ the post - crisis fix : regulatory or monetary policy remedies? ” paper presented at the reserve bank of india ’ s first international research conference ( february ) ; p. de grauwe and d. gros ( 2009 ), “ a new two - pillar strategy for the ecb ”, ceps policy brief no. 191. see : o. blanchard, g. dell ’ ariccia and p. mauro ( 2010 ). “ rethinking macroeconomic policy ”, imf staff position note no. 10 / 03 http : / / www. imf. org / external / pubs / ft / spn / 2010 / spn1003. pdf. by most leading central banks. at the ecb, we are fortunate that the primacy of price stability has been made explicit. with this in mind, it is difficult to attribute any pre - crisis “ policy error ” to the pursuit of the wrong monetary policy objective. nonetheless, we are already witnessing the emergence of siren calls to change the objective – in particular, for monetary policy to target a higher steady - state inflation rate, difficult to reconcile with price stability. these calls must be resisted. emphasising the primacy of price stability objective over the medium term does not imply central bankers should be, in the words of mervyn king, “ inflation nutters ”. 9 using theil ’ s framework to characterise the monetary policy problem also helps to clarify its dynamic nature. recognising the long and variable lags in the transmission of monetary policy and the inevitability of short - term shocks to price dynamics, policy - makers need to adopt a mediumterm orientation in their decisions. attempts to fine - tune price developments on a short - term basis are doomed to failure. such attempts are likely to impart an excessive activism to policy - making, such that interest rate decisions add volatility to the economy rather than stabilise it. in adopting an appropriate medium - term orientation, monetary policy - makers are accorded an extra “ degree of freedom ” in setting the policy stance. there can be several paths of interest rates consistent with the maintenance of price stability over the longer run. at least in principle,

within the banking sector can occur over time, creating increasing vulnerability. 17 low interest rates also encourage a higher level of leverage. because financial intermediaries – whether banks, broker - dealers, shadow banks, or hedge funds – finance themselves with short - term liabilities, central bank decisions on the level of short - term rate affect their marginal price of leverage. as a result, the behaviour of financial intermediaries – which, by their nature, have high levels of leverage – can be strongly influenced by even small changes in short - term rates. 18 low levels of interest rates encourage higher levels of leverage and, as a result, an accumulation of additional risk on bank balance sheets. through all these channels, a prolonged period of low short - term interest rates can support the accumulation of risks and financial imbalances on the balance sheets of both financial intermediaries and the private sector. these imbalances render the economy vulnerable to financial crises : if confidence evaporates, lenders call in loans, balance sheets contract and a painful readjustment is required, with adverse implications for financial stability and the real economy. in particular, the build - up of leverage within the financial sector may unwind abruptly, leading to a tightening of overall financing conditions. 19 such thinking sheds light on recent developments in the run - up to the financial crisis. viewing the impact of globalisation on goods prices as the manifestation of a positive supply shock, we can map this abstract scenario into our experience of the past decade. at the global level, the incorporation of emerging markets into the world economy weighed down on price developments ( especially of manufactured goods ). in response to the resulting benign inflation developments, the prevailing inflation targeting orthodoxy led to the adoption of an accommodative monetary policy stance. in retrospect, such accommodation was probably inappropriate, at least to the extent that it supported the financial imbalances and asset price bubbles that underlay the recent financial crisis. failure to take into account financial factors and channels of transmission led to a mis - calibration of the monetary policy response to the impact of globalisation. a simplistic account of the financial sector may have had other, adverse implications for the conduct of monetary policy in recent years. within the canonical new keynesian model, financial markets are “ perfect ”. on the basis of arbitrage considerations, long - term interest rates and other yields and asset returns all derive from the expected path of short - term interest rates determined by the