Likewise, a  4  Winje, H. and L.T. Turtveit (2014): “Norwegian banks’ adjustment to higher capital requirements”, Norges Bank Staff Memo 14/2014. BIS central bankers’ speeches  3  pronounced economic downturn with increased bank losses can be addressed by lowering both the key policy rate and the capital buffer. In other situations, it may be appropriate to reduce the key policy rate while at the same time raising the level of the capital buffer. If, for instance, there are prospects that inflation will become too low at the same time as debt and house prices are rising rapidly, the key policy rate will be reduced, in line with its primary task of maintaining a nominal anchor for the economy. Unwarranted negative effects on financial stability of lower interest rates could in this case be counteracted by raising the level of the countercyclical buffer. Macroprudential policy and stricter banking regulation help to reduce systemic risk, but we cannot act on the assumption that tighter regulation alone will suffice to prevent future crises. Monetary policy, on the other hand, has well-documented effects on house prices and debt. Thus, monetary policy deliberations at Norges Bank give weight to mitigating the risk of a build-up of financial imbalances. By taking financial stability considerations into account, we seek better, more stable outcomes for inflation and output in the longer run. A simple analytical framework can serve to illustrate this point. Chart: Framework Consider a central bank with a flexible inflation targeting regime.
The model-based predictions can be interpreted as the probability that the economy is in a precrisis period. The chart shows estimated crisis probabilities for the US, Spain, Norway and the UK. The band reflects various combinations of explanatory variables and trend estimation methods. 3 The dataset covers the period from 1970 to 2013, with a total of 27 events defined as crises, of which 11 are associated with the financial turmoil in 2008–2009. As you can see from the chart, the estimated probability of a crisis increased markedly in the years ahead of the financial crisis in 2008–2009, although the UK is the exception in that context. Crisis probabilities also increased in the US ahead of the US Savings and Loan crisis, in the UK ahead of the UK’s small-bank crisis and in Norway ahead of the banking crisis in the late 1980s and early 1990s. All these episodes featured rapid growth in credit and rising real estate prices. 2  See Anundsen, A.K., F. Hansen, K. Gerdrup and K. Kragh-Sørensen (2014): «Bubbles and crises: The role of house prices and credit», Norges Bank Working Papers 14/2014. 3  The indicators are incorporated in growth form or as deviations from estimated long-term trends. 2  BIS central bankers’ speeches  The empirical results support our choice of key indicators of financial imbalances. Household and corporate credit, house prices and banks’ wholesale funding ratio are statistically significant in the models and clearly influence the estimated probability of a crisis.