In our monetary policy analysis, we must assess whether output and employment lie above or below their long-term trends; in our financial stability analysis, we must assess whether credit lies above or below its long-term trend. Both policy areas must give weight to the risk of a build-up of financial imbalances. The communication of monetary policy also offers some lessons. Whereas monetary policy was previously veiled in secrecy, we are now open about our view of the likely future interest rate path. The theoretical foundation for transparency builds on the notion that prices are sticky. Adjusting prices goes smoother if central banks’ response pattern is known. Market participants then have a solid basis for forming expectations about future interest rates. The same line of reasoning may be valid with regard to transparency about our advice on the countercyclical capital buffer. It takes time for banks to adapt to changes in capital BIS central bankers’ speeches  5  requirements. A predictable policy will facilitate the adjustment process. The size of the friction is difficult to assess. Banks tend to restrict themselves to a very limited number when they present their options for increasing capital ratios. If banks choose to raise new equity capital, the adjustment process will be considerably faster. Irrespectively, we believe that predictability will facilitate adjustment.
All these instruments, with the exception of foreign exchange reserves and interest rate caps, have been used or are being used in practice.” 2 Milton Friedman had already predicted five years earlier that this system of managing the economy would collapse because economic policy expectations reduced the scope for pursuing the objective of permanently low unemployment. Friedman proved to be right. The Great Inflation in the 1970s and into the 1980s, combined with an economic management crisis, spurred a new paradigm shift in the field of economics. Regulations and planned economies had to give way to economic thinking guided by the central role of wellfunctioning markets. The shift also occurred in Norway, but it took somewhat longer than in other countries. The US banks that had been harnessed in the 1930s were freed up. The trend gradually pervaded Europe. The freeing up of the banking sector was a bit too abrupt for many and banking crises again made their appearance in western countries, not least here in the Nordic countries. The big picture is nonetheless one of a long period of stable growth and low inflation from the 1990s and into the 2000s. At the same time, debt levels rose in many countries. Deregulation fuelled the flow of capital across borders. Banking regulation had to be coordinated at an international level. The Basel regulatory framework came into place towards the end of the 1980s and represented a breakthrough. But the regulations would prove to be too weak.