Since speculative activities naturally fit into this risk-return temporal pattern, given that they usually yield substantial immediate profits at the outset at the expense of a possible once-for-all large loss at an uncertain future date, a more cautious credit strategy will tend to penalise the funding of self-fulfilling asset-revaluation processes. Forward-looking risk management that is aware of how risk-drivers change through the cycle and in stress conditions will tend to build shock absorbers to be used when difficult times arrive. I will return later to this idea and how Basel II encourages the appropriate use of capital buffers. Let me add now that the idea of building robustness in good times is not only a prudent policy, it is also theoretically consistent because we all have a tendency to think that risks increase in bad times. From my perspective, this is only true in part. A better description is to say that exposures and therefore risks increase in good times and that in bad times these risks materialise. On top of that, to the extent that risk assessment and control methods become more formalised and rigorous, this will lessen the likelihood of making bad decisions and will improve risk-adjusted pricing policies. It will also contribute to the prompt detection of errors and deviations from targets, allowing banks to implement corrective measures at an early stage.
Third, financial stability may be in danger when strong action by central banks during a crisis leads market participants to rely excessively on central banks as a backstop in case of negative shocks. This is the moral hazard problem.9 Taken together, these channels underline the risks the current “low-for-long”-situation presents for financial stability. These risks have to be acknowledged and acted upon. The fact that it is possible for these risks to exist while monetary policy is responding appropriately to the macroeconomic situation perfectly illustrates the Tinbergen principle – the number of instruments must equal the number of policy goals.10 In the current environment, the interest rate cannot be the instrument of choice for addressing financial stability risks. The answer is to give more weight to what are known as macroprudential instruments implemented as a complement to, and along-side a monetary policy that remains firmly focused on price stability. These instruments directly target the risk-taking behaviour underlying financial stability risks. This is exactly the approach chosen in Switzerland with the activation of the countercyclical capital buffer. By forcing banks to build up additional capital in the current phase of strong credit growth, the regulators aim at improving the capacity of the banking system to bear losses in the event that the identified risks materialise, while also limiting the further build-up of these risks. Outlook We are now in a position to derive the implications of our analysis for the interest rate outlook.