balance sheets Risk tolerance  Private financial system  Percentage of annual nominal GDP 120  120  110 100  110 100  90 80  90 80  70 60  Financial institutions - lending to private non-financial sector (a)  50 40 30 20 10 0 2005  Bank of England(b)  2008  2011  2014  Open for business  70 60 50 40  Unconventional Central banks MP  30 20  Normal conditions  10 0 2017  Liquidity crisis  Degree of systemic stress  Sources: Bank of England, ONS (a) Data as at February. Sterling net lending to non-financial corporations and household sector. (b) Data as at February. Final data point shows the latest published balance sheet data, at 29 February 2016, plus the increase in the loan to the Asset Purchase Facility since this time. The financial instruments underpinning these expansions tend not to be particularly complex when compared to those on commercial bank balance sheets. But the Bank of England has also accumulated material new contingent exposures, reflecting its much wider post-crisis range of policy responsibilities, and a more comprehensive liquidity insurance toolkit. The Bank’s new responsibilities for banking supervision, macro-prudential policy and resolution imply a range of potential new calls on its balance sheet.
Chart: Financial stress arises The red lines in the panel again show a scenario where the central bank does take into account the possible effect of monetary policy on financial stress. When financial turbulence occurs, the economic setback is less pronounced and less prolonged than if the central bank had not taken this risk into account in monetary policy, as illustrated by the blue lines. The benefit gained from keeping the interest rate somewhat higher in the short term is in this case a more stable path for inflation and output over time. This framework is highly stylised. In the actual implementation of monetary policy we are faced with a number of difficulties. First, developments in debt and house prices depend on a number of factors in addition to the interest rate. Second, both the costs and the benefits of leaning against the wind are uncertain. What we do know, however, is that the economic consequences of a financial crisis are so serious that an insurance premium is worth paying. Let me now return to the Norwegian economy and to the trade-offs in recent interest rate setting in Norway. As I said earlier, the key policy rate in Norway has in recent years been kept slightly higher than implied by medium-term outlook for inflation and output, in order to mitigate the risk of a build-up of financial imbalances. However, through last autumn, oil prices fell sharply and the growth outlook for the Norwegian economy weakened.