itself has become more complex, with a wide variety of players and activities, many of them unregulated. the migration of financial risks across these players and activities has made it difficult to discern how shocks are transmitted across the system and how they affect financial stability. then there are feedback loops from the financial system to the real economy, with implications for price and output stability. most worryingly, we seem to be confronted with a trade - off between price stability and financial stability, at least in the short term. to borrow a phrase from a recent award - winning movie, everything seems to be related ; there are financial vulnerabilities everywhere ; and economic and financial shocks seem to happen all at once. okay, that sounds exaggerated, but i think you get my drift. as with the multiverse, there is much that we do not know about the complex interactions between the real economy and the financial system and their implications for price and financial stability. but policymakers are not entirely clueless. let me set out four key propositions based on the experience of the last decade : securing both monetary and financial stability requires an integrated framework, combining monetary policy, fiscal policy, and macro - financial policies ; financial sector vulnerabilities are best addressed using a variety of macro - financial policy tools in a coherent manner ; monetary policy should remain focused on inflation control but its implications for financial stability must be taken into account ; fiscal policy plays an important role in helping to secure both price stability and financial stability ; let me elaborate on each of these. an integrated policy framework first, securing both monetary and financial stability requires an integrated framework, combining monetary policy, fiscal policy, and macro - financial policies. macro - financial policies include macroprudential measures, foreign exchange intervention, and capital flow management measures. there are three reasons why we need an integrated policy framework. one, there are important interactions between monetary policy and the financial system. in the last decade, policymakers around the world have gained better appreciation of the increasingly important role that the financial system plays in the transmission of monetary policy. as jeremy stein puts it, “ monetary policy is fundamentally in the business of altering risk premiums. ” [ 3 ] accommodative monetary policy reduces risk premiums and can lead to unsustainable credit growth and asset price increases. correspondingly, monetary policy tightening can trigger a sharp reversal in sentiments and risk premiums, which can impair credit supply and trigger financial failures. two, capital

flows and exchange rates cannot be ignored in macro policy settings, especially in emerging market economies. in advanced economies, capital flows and exchange rate movements are generally viewed as equilibrating mechanisms outside the remit of macro polices. but for emerging market economies, they can spell serious macroeconomic and macro - financial trouble. capital flows can fuel domestic credit and asset price bubbles. capital flows can induce exchange rate fluctuations that are disconnected from macroeconomic fundamentals. in the face of large and volatile capital flows, a freely floating exchange rate can become a shock amplifier rather than a shock absorber. studies by both the imf and bis find that exchange rate movements have perverse, destabilising macroeconomic and financial effects in emerging market economies, in contrast with their stabilising effect in most advanced economies. capital flows can compromise the monetary policy latitude of emerging market economies. studies show that their monetary policies respond to movements in us interest rates and exchange rates, besides their own domestic macroeconomic conditions. helene rey and silvia miranda - agrippino find that us monetary policy moves can induce changes in risk premiums across countries, move the global financial cycle, and challenge the monetary policy autonomy of emerging market economies. three, there appears to be a short - term trade - off between price stability and financial stability. macroeconomic theory and empirical evidence tell us that although there is no long - run trade - off between price stability and employment, there is a short - term trade - off. this is expressed as a “ sacrifice ratio ”, or the increase in the unemployment rate necessary to achieve a given reduction in the inflation rate. likewise, could it be that while there is no long - term trade - off between price stability and financial stability, there is a short - term trade - off? in the current conjuncture, for example, there are concerns that monetary policy tightening to bring down inflation could trigger contagious financial failures. is there an analogous “ sacrifice ratio ” between price stability and financial stability? these short - term trade - offs call for a mix of monetary and macro - financial policies to meet the twin goals of financial stability and price stability. combining the use of monetary policy and macro - financial policies can mitigate tradeoffs between objectives. studies by both the bis and imf have found that policy combinations can be more effective than using a single instrument. claudio borio and colleagues at the bis find that when low inflation in advanced economies required loose monetary policies, tightening macroprude