As late as 2008, the year 2006 was still being seen as one of wasted resources. But by 2009, with revised estimates, the experts were telling us that three years earlier, the euro area was overheated and output exceeded its potential by a significant amount. Mismeasurement of the output gap can lead to errors not only in monetary policy – if and when central banks incorrectly rely on this information – but can also lead to mistakes in fiscal policy. In 2006 we had a fiscal deficit in the euro area as a whole. Alarms about fiscal soundness should have sounded before the crisis. But the alarms would have sounded much louder if the EC, the IMF and others had not suggested that the economy was running below potential. Inappropriate reliance on mismeasured output gaps can lead to complacency during good times. 2  BIS central bankers’ speeches  I recount this example about how the output gap can be misused in policy debates because once again, as we are coming out of the crisis, some voices are stressing the extent of the output gap that the euro area is facing today, perhaps drawing conclusions about policy that could again be reversed as time goes by. The focus on price stability must remain unrelenting. *** That said, another lesson is the following: the central bank focus on price stability is insufficient to maintain overall stability in the economy.
Whether a quake seems likely to occur soon has no bearing on this. For resilience in structures, the best indicator of underlying vulnerability is how close the city is to the fault line or plate boundary. On that basis, Apple’s new California HQ uses new earthquake resilient technology. 3  For resilience in the financial system, it is how much debt there is in the economy (or economies) to which it’s exposed. That’s why, when we come to decide how big the banking system’s buffers of loss-absorbing capital should be, we don’t focus on any economic tremors we may feel. We don’t insist on tougher standards just because trade tensions threaten to slow the world economy or changes in sentiment hit financial markets, or because uncertainty is weighing on the domestic economy. Instead we focus on debt – a key driver of how far up the Richter scale economic earthquakes tend to be. 4 Think of a build-up of debt as being the economic equivalent of building close to a fault line. When a quake hits, the impact is greater and more resilience is needed in the structures. This focus means we can appear contrarian. Debt has a habit of increasing in calm periods, when those in the financial system think it’s safe to take more risks. So we can find ourselves demanding tougher standards when risks are thought by many to be low. And we don’t start demanding them when the tremors start, when risks are thought by many to suddenly be high.