understanding of the current financial crisis. 12 the first line of defence is better regulation while misery loves company, we must be careful not to generalize recent failings. the foregoing description of liquidity cycles assumes that agents can extend mismatches, increase leverage, and boost collateral - based finance if conditions appear favourable. in other words, regulatory quiescence or arbitrage is also required. neither has been universal. the oft - derided existing regulatory tool kit has been deployed more effectively in some jurisdictions than in others. indeed, many inflation targeters achieved their price stability objectives and retained well - functioning, appropriately exuberant financial systems ( including canada, australia, and new zealand ). this advantage is easily replicated and could be further enhanced if an effective macroprudential approach were developed. 13 the implementation of monetary policy will have to change new macroprudential tools will change the transmission mechanism, potentially in real time if discretion is used in their application. as a result, central banks will need to coordinate across conventional monetary policy tools and those emerging financial stability tools that have monetary policy implications. this could prove challenging. fortunately, we are already on the learning curve. strains in the interbank, repo, and credit markets dramatically tightened the effective stance of monetary policy. in response, extraordinary liquidity facilities were deployed. the effectiveness of these facilities varied across jurisdictions with the health of core financial institutions and the scale of shadow banking systems. a common lesson is that current market infrastructure does not ensure continuously available core funding markets. a wholesale restructuring of funding markets is thus required. promising avenues to break such liquidity spirals include introducing clearing houses, standardizing products, implementing through - the - cycle margining, and ensuring more effective netting. as the ultimate provider of liquidity to the system, central banks should consider whether to adapt our facilities to support continuous private liquidity creation. through such measures, we can reduce the procyclicality of the transmission mechanism. how other emerging macroprudential tools are implemented also matters. if these new tools, such as time - varying capital buffers, are purely rules based, perhaps linked to aggregate credit growth, their impact on the transmission mechanism may be determined with see white ( 2009 ) for the definition and broader discussion. an alternative extreme is the “ dark side ” of credibility, whereby agents make bigger mistakes as a consequence of believing central banks will always get policy right. this is consistent with the exuberant state. for

this all suggests that if monetary policy must lean into the wind for financial stability purposes, then the price stability objective should change in a manner consistent with the desired variability in the price path. this could be accomplished by combining flexible inflation targeting and price - level targeting. in general, policy - makers would rely on enhanced macroprudential regulatory frameworks to curb the enthusiasm in the financial system. 19 while the policy interest rate would not be the primary tool for promoting financial stability, it occasionally might be used to support macroprudential tools. leaning into the wind for financial stability purposes could thus result in temporary deviations from the inflation target. to avoid threatening the monetary policy objective, these deviations could be recovered over time in order to keep the economy on a predetermined path for the price level. the prospect that the target rate could be deployed in this manner would help maintain a balance between macro and idiosyncratic risk. the discipline of a transparent and accountable price stability objective via the price - level target could maintain central bank credibility. however, authorities, if they are granted flexibility, must be sufficiently disciplined not to decide that all shocks are uniquely virulent. this suggests that exercising any flexibility to lean into the wind for financial stability purposes should be episodic, the product of statedependent rules. that is, the central bank would need to make the judgment not only that an exuberant state is developing, but also that macroprudential tools alone are insufficient to counteract it. the possibility that the central bank would make this judgment would rise with the degree of excess credit creation, providing a partial check on emerging complacent financial expectations. a crucial motivation for this idea is that the balance of long - term price stability ( i. e., achieving a predetermined price path ) with higher short - term variability ( due to the occasional leaning ) is ultimately more consistent with achieving financial stability than conventional inflation targeting. 20 this reflects the relationship between price stability ; low, relatively stable interest rates ; and the emergence of exuberant financial states of the world described earlier. however, it also presumes that regulation is not up to the task. it is important to stress again that the first line of defence against these dynamics must lie in improved regulation and market structure. it is also important to remember that there are concerns about macro stabilization under price - level targeting. in particular, the performance of a price - level target may suffer if inflation