If the costs associated with a crisis are sufficiently large, systemic risk can be considerable even if the probability of a crisis seems small. As underlined in the theoretical literature, the economy can be vulnerable to substantial deleveraging when debt is at a high level. Previous economic downturns provide confirmation of this. The costs of a crisis may then be substantial. The empirical models can provide support when we assess financial imbalances and whether a crisis is emerging. At the same time, humility is required and we must recognise that our ability to provide a precise estimate of systemic risk is limited. No two financial crises are alike, and the financial system is constantly evolving. There are many sources of systemic risk and new ones may emerge – not least when new regulations are introduced. We must be prepared for possible changes in the predictive power of the indicators. Norges Bank will therefore always have to exercise professional judgment in its assessment of systemic risk. The aim of macroprudential regulation is to strengthen the resilience of the financial system and dampen the build-up of financial imbalances. The purpose of the countercyclical capital buffer is primarily to increase banks’ resilience to loan losses in a future downturn. If the BIS central bankers’ speeches  3  buffer functions as intended, banks will tighten lending to a lesser extent in a downturn than would otherwise be the case. In addition, the buffer may to some extent dampen high credit growth during an upturn.
In doing so, I will focus on two prime channels underlying the second stage of transmission: the exchange rate channel and the real interest rate channel. My remarks will therefore be neither exhaustive nor complete, given that monetary policy can affect the economy through many other channels as well, such as its impact on the valuation of equities and, hence, on firms’ cost of capital and investment decisions, Tobin’s q in short.3 Another channel of relevance is the bank lending channel as formalised by Bernanke and Gertler (1995). But by focusing on the exchange rate and interest rate channels, we can get a good understanding of how effective recent policy measures have been. In particular, I will show that monetary policy-induced exchange rate movements may have considerable impact on consumer prices, but that this relationship depends on the state of the economy and the shocks driving it, much in line with the recent literature in this field. And I will show that the New Keynesian Investment and Savings (IS) curve is alive and well in the euro area – that is, aggregate demand responds to changes in real ex ante interest rates, and can also be shown to have done so in recent times, provided it is measured properly. A state-dependent exchange rate pass-through Let me start with the exchange rate channel – a channel that has been heavily debated in recent months in the light of the large movements that we have observed in the foreign exchange market.