Svein Gjedrem: The macroprudential approach to financial stability Keynote address by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), at the conference entitled “Monetary Policy and Financial Stability”, hosted by the Oesterreichische Nationalbank (Austrian National Bank), Vienna, 12 May 2005. Please note that the text below may differ slightly from the actual presentation. The  Charts in pdf-format can be found on the Norges Bank’s website. *  *  *  Introduction First of all I would like to thank the organisers for inviting me to this conference. It’s a great pleasure to be given the opportunity to share with you some views on financial stability issues. Financial stability has become an increasingly important objective in economic policymaking during recent decades. In the 1980s, direct regulation of credit markets and capital flows was dismantled in many countries. This has prepared the ground for an expansion of the financial system at a faster pace than other parts of the economy. In this process, the financial system has gone through important structural changes and become more complex. The instruments have become more intricate, the activities more diversified and the risks more mobile. As a result of increasing cross-industry and cross-border integration, financial systems have also become more interwoven, both nationally and internationally. In parallel with the strong growth of the financial system, we have seen more frequent instances of widespread financial distress. The resulting macroeconomic costs have often been sizeable.
Mr. Bernanke’s quote recognises the channel between the stock-market boom and incipient inflationary pressures.7 Mr. Issing focuses attention on financial imbalances on the grounds that strains in the financial system may conflict with price stability in the long run.8 Mr. Heikensten calls attention to the possible repercussions of financial imbalances on the real economy in a situation where the household debt burden is high and interest rates are increasing rapidly.9 Seen from an institutional perspective, flexible inflation targeting is becoming an increasingly common monetary policy regime. With a target horizon that is forward-looking and sufficiently flexible, it is possible to take into account the impact of potential financial imbalances on future inflation and output. However, it is important to keep in mind that the unwinding of financial imbalances may lay many years ahead, well outside the horizon for the inflation target. Some situations may require a careful weighting of the probabilities and costs of not reaching the inflation target within a medium-term horizon against possible economic turbulence further ahead. In the worst case, this turbulence may result in the actuation of a financial crisis. Another interpretation of the role of monetary policy is that it demands that financial instability is taken into account beyond its impact on inflation and output. For instance, structural costs may arise as a result of incorrect decisions by economic agents, based on incorrect information in the period characterised by financial imbalances.