The second part of my remarks will touch on the key imperatives to best prepare us for the new global landscape, so as to be better positioned to succeed and survive in this new environment. Policy-makers in the world economy have continued to be confronted with policy challenges since the onset of the global financial crisis. While the policy responses have focused on addressing the origins of the crisis – on the extensive build-up of excesses, the over-leverage and over-indebtedness of the private and public sectors, the breakdown in the functioning of financial markets, the loss of competitiveness, and the loss in confidence in the financial system and the economy, the concern now is on achieving a sustained economic recovery that is accompanied by job creation. Half a decade into the crisis, and this has yet to be achieved. In the recent months, the global economy has again experienced a broad-based moderation in growth from an already modest pace. This has stemmed largely from the renewed weakness of the economic recovery in several of the major advanced economies. In the United States, the significant monetary accommodation, reinforced by the large scale financial market interventions and the significant fiscal stimulus during the early stage of the crisis, has averted an economic depression, but it has not, however, brought about a sustained recovery. In Europe, an economic contraction is being experienced, resulting from the combination of fiscal austerity, tight credit conditions, and the continued uncertainty and volatility in the financial markets.
Another effect of financial innovation is thus to create asymmetries in the reaction of the economy to monetary policy: for example, the slow build-up of bubbles during periods of monetary easing followed by an abrupt retrenchment when monetary policy tightens. Note that there is currently a debate as to whether this inherent procyclicality of financial systems is amplified by our accounting and prudential regimes. Fourth, it may be that modern financial innovation creates new discontinuities in the financial system and dynamics. When conditions are less benign than usual, the transmission process along the interest rate curve becomes non-linear: a striking feature of this summer’s events was the surge in the short-term money market. Wider and variable spreads between term funding rates (of which many bank loans are priced off) and policy rates may reduce the efficiency of interest rate adjustments when needed. Innovation also reinforces the mechanism of the "financial accelerator", through which the level of asset prices influences credit distribution (through collateral values and, now, its impact on banks tier one ratio), then the real economy; and, in return, the real economy impacts asset prices and values. This spiral can go upwards, or, as we see now, downwards. Overall, I believe that central banks have coped well with these challenges over the past ten months. The monetary policy response has differed across industrialised countries, as warranted by the differences in economic situations and outlooks.