But even if that is achieved, I know from my own experience how difficult the actual implementation sometimes can be, not least for political reasons. The events of the past decade have made it clear that greater efforts are needed to strengthen the functioning of markets. I would like to make the point that today’s favourable trends in the world economy should not lead us to conclude that the danger is over. We have witnessed too many crises in the last decade not to know that market confidence can suddenly shift. Instead, policymakers BIS Review 65/2000  2  throughout the world must continue to work on forestalling new problems both because some evident threats to international financial and economic stability still remain and because there may well be vulnerabilities that are less evident. But the chances of the global economy continuing along the path towards sustainable growth without disruptive financial instability can be enhanced by implementing appropriate reforms. Monetary stability Let me now turn to monetary stability. In the last decade a growing number of countries have chosen to conduct monetary policy with an explicit target for inflation. One reason behind this choice has no doubt been these countries’ poor experience with a fixed, but adjustable, exchange rate regime. The first country to formally adopt a policy of targeting inflation was New Zealand in 1990. Canada did the same in 1991, followed by the United Kingdom, Sweden and Australia. Other countries have also introduced some variant of inflation targeting since then.
If asset prices have been driven up to unsustainable levels that do not correspond to the underlying fundamentals, we are faced with a special kind of problem. We know from experience that speculative asset price bubbles eventually burst. When they do, collateral values will fall and balance sheets deteriorate, potentially threatening the stability of the banking system. To avoid this kind of development, the central bank needs to closely monitor the potential for excessive credit growth and the possibility of asset price bubbles building up. It seems that historically the forming of speculative price bubbles has been closely linked to an excessive expansion of credit. But we need to operationalise both the concept “excessive” and the difficult concept of an asset’s “fundamental value”. As history has shown us, judging to what extent rising asset prices reflect strong fundamentals, rather than the “irrational exuberance” of investors, is easier said than done. Nevertheless, certain important risks related to asset prices need careful watching in today’s world. The first risk is that imprudent lending could fuel unwarranted asset price increases - as so often in the past. Although there is little evidence to date of a general lowering of credit standards, credit growth has been very rapid and loans to finance equity purchases have risen sharply in some countries. BIS Review 65/2000  4  Ensuring that investors are not sheltered from the consequences of their sometimes misguided investments is important for maintaining prudent lending standards.