As inflation expectations rise, the expected real interest rates — the real burden incorporating the price rises — will fall. Let me elaborate on what I mean by this, as it is somewhat difficult to understand. Suppose you borrow money at the rate of 3 percent.
Another source of difficulty was that the models used to assess market risk were based too simplistically on established statistical correlations. They did not take adequately into account other types of risk, such as liquidity, volatility and event risk. Widely used value-at-risk models caused financial intermediaries to liquidate assets when volatility in asset prices increased.