In the worst case, falls on the stock exchange that correct overvaluations can lead to financial instability, if share prices have been driven by pledged shares and if the market participants are in some cases unable to pay back their loans. This can result in panic sales, exaggerated falls in prices and credit institutes facing difficulties as a result of exposure to households and institutions that have become insolvent. This result risks leading to large fluctuations in the real economy. Critics of the Federal Reserve in the USA claim that when Alan Greenspan coined the phrase "irrational exuberance" in 1996, it was clear that prices on the stock exchange had risen too much and that this development should have been counteracted. Nothing was done and the rise in share prices continued until March 2000. Since then the stock exchanges have fallen, Nasdaq by 70 per cent, and the fall on the stock exchange risks pulling the USA down into a recession that could have been avoided. However, comes the objection; is it really possible to realise when a stock exchange has risen too much? The answer is that prices on the stock exchange must have some relation to the underlying development of productivity in trade and industry, to company profits and to the market's pricing of risks. Of course, it is not possible to determine precisely when the stock market has risen too much or when it is undervalued. However, it should not be too difficult to detect obvious deviations.
This is partly because these can cause instability in both the real economy and prices when the bubble bursts and partly because the stability of the banking system could be threatened. Measures to avoid financial imbalances being built up are thus motivated on the basis of both of the Riksbank's objectives; to maintain price stability and to promote a safe and efficient payment system. However, the question is how effective the interest rate is as a weapon – perhaps other means can be utilised. Examples of such measures are monitoring the financial institutions and making capital adequacy requirements of them. The analyses made by the Riksbank in its Financial Stability Report are also aimed at drawing the attention of the banks and other authorities to any problems and they thus play a role in this context. BIS Review 39/2001  3  How great are the problems created by the imbalances in the USA? Is there a risk that the imbalances in the American economy are so great that the process of adaptation back towards a balance will dramatically intensify and prolong the economic slowdown? It can be noted that none of the ten major economic analysts of the American economy assesses that the USA will suffer a recession during the next few years. Firstly, it is probable that the growth potential that can be created by developments in technology is far from exhausted. There should thus be good reason for at least some of the optimism that has comprised a basis for earlier developments.