A prolonged period of even lower interest rates would increase the risk that debt and asset prices will be driven up to levels that are unsustainable over time. We thus obtain a smoother interest rate path when we also give weight to the other two criteria. The criteria and loss function reflect the Bank’s reaction pattern in the period following the financial crisis. We are responding to new insight and lessons learned. The loss function is a mathematical illustration and must be regarded as a simplified representation of the more extensive assessments underlying interest rate decisions. Interest rate setting is based on the Executive Board’s assessment, not a model calculation. Mathematics and models can, however, clarify the alternatives. There is considerable uncertainty as to the effect of low interest rates over extended periods on risk-taking behaviour and the buildup of financial imbalances. 7 In this regard, we are in quite uncharted waters. How financial imbalances build up is not explicitly considered in the analytical apparatus. Work is in progress both in Norway and internationally to further develop the economic models used in monetary policy analysis. As we gain new insight and gather experience, our assessments of economic relationships may change. This will also influence the formulation of our models. 7  Monetary Policy Report 1/12, box on pages 15–16, Norges Bank, and “Norges Bank’s new monetary policy loss function – further discussion”, Snorre Evjen and Thea B. Kloster, Norges Bank Staff Memo 11/2012.
At the same time, the increased levels of non-resident investments in Malaysian financial assets had pushed non-resident holdings of Malaysian government bonds to rise to the height of 33.6% in May 2013. These heights came with costs, heightened risks and vulnerabilities. From the Taper Tantrum in 2013 onwards, our markets went through several bouts of volatility. These were largely driven by volatile portfolio flows. During the Taper Tantrum in 2013 itself, we saw outflows of USD19.1 billion and a depreciation of 9.7% of the ringgit against the US dollar. Despite this, our capacity, capability and resilience in managing these sizable and volatile financial flows have been fortified in a number of ways. Our economic fundamentals have remained healthy and our financial market is more diversified and well-developed. This enhanced the ability of the financial system to absorb capital inflows and outflows, thereby minimising disruptions while ensuring that these flows can be effectively intermediated to support real economic activity. Malaysia’s exchange rate regime has also accorded the necessary flexibility for the exchange rate to adjust to the changing conditions. This has provided a good balance between flexibility and stability. Our ability to manage domestic liquidity has also improved significantly, supported by a wider range of instruments to conduct monetary operations and strengthened surveillance systems. Pervasive impact of the offshore markets However, one noticeable observation over the years was that, for each episode of volatility we faced, the subsequent calm would see an even larger build-up of risks.