It showed that there existed areas in which we needed to think further or maybe even revitalise old knowledge. Not least, it  6  BIS Review 68/2010  made it apparent that, while central banks had become more adept at handling normal shocks to demand and supply, there remained a great deal to be learned regarding the manner in which imbalances on the financial markets ought to be handled. So what consequences can we expect the crisis to have for central banks’ method of working in the future? Is there reason to supplement current monetary policy reasoning – and, if so, how? A large part of what I will address here today consists of matters that are currently the subject of intensive international discussion. The final result of these discussions remains to be seen. Nonetheless, let me think aloud on the manner in which central banks’ work may be affected and on the challenges we will face. Effects on potential output and growth? One challenge concerns attempting to assess the manner in which the crisis will affect the economy’s long-term production capacity or potential output. This is significant for several reasons. Firstly, the deviation between actual and potential output, the output gap, is a measure of the stability of the real economy. Secondly, the output gap can affect the manner in which inflation develops. If the production of an economy exceeds its long-term production capacity (that is to say, if the output gap is positive), this tends to exert upwards pressure on inflation.
In most areas, inflation has fallen significantly and has been more stable than previously. The real economy also seemed to be developing with more stability, which was probably partly due to the fact that the policy was being conducted in a better reasoned manner than previously. There may be those who believed that most problems had been solved, and that the improved stability of the macroeconomy was here to stay. But the Great Moderation would turn out to be a deceptive calm. But an improved monetary policy was not enough The recent period has seen frequent discussion of the financial crisis and its causes, to put it mildly. Consequently, I do not intend to go into any detailed description of the development of the crisis, but will remain on a relatively intuitive level. The origin of the financial crisis lay in a number of interacting macroeconomic and microeconomic factors. However, the core of the crisis was that the banks and other participants took on too much debt in relation to the risks they were taking. Shortcomings in the regulatory framework, combined with a lack of understanding of new complex financial instruments, contributed towards the altogether too low pricing of risk by the market. Regulatory frameworks and supervision also failed to ensure that the banks had enough high-quality capital to maintain confidence when the economy took a downward turn and inflated asset values fell.