Globally interconnected markets have resulted in a situation in which financial institutions everywhere have been hit, even if not exposed to the institutions or assets at the core of the crisis. My home country Sweden is a good example of this. What we have witnessed in recent months, since the default of Lehman Brothers, is the acute phase of a global financial crisis. To respond, authorities have taken action to prevent a systemic break down of the financial system. Both the US and the EU have delivered financial support plans committing governments and central banks to providing the necessary support to the financial industry. BIS Review 134/2008  1  These plans are now being implemented and we cannot yet be certain of their success. However, in my view, the support plans contain the necessary measures to solve the most critical issue right now, namely to restore market confidence by providing guarantees to creditors that their money will be repaid. Therefore, the prospects for restoring financial stability and enhancing the availability of credit for firms and households should be good. That the support plans also provide measures for government capital injections and takeovers is obviously good, but for the purpose of getting markets to function properly ownership issues really are of secondary importance. After all, what creditors are looking for is to get their money back. To them it should not really matter from where or from whom that money comes.
Essentially, it all comes down to a choice between two alternatives. On the one hand, central banks can try to slow down a worryingly rapid price rise in the housing market by keeping interest rates higher than they otherwise would have been. The obvious risk is that if increasing prices actually are driven by fundamentals, then an incorrect assessment has  2  BIS Review 134/2008  been made and demand in the economy will be subdued unnecessarily. But if the assessment was correct, a rapid downward correction in house prices may be avoided, or at least mitigated, as well as a subsequent fall in demand. On the other hand, central banks can disregard the fears and refrain from raising the interest rate. If price increases in this case are due to fundamentals a needless slow down in demand will be avoided. But if prices are due, for instance, to over-optimism among households and lenders, then severe problems may occur in the future when there is a rapid downward adjustment of house prices and a subsequent fall in demand and inflation. Which of the two alternatives is preferable can always be discussed, and may quite likely vary from case to case. However, it is far from obvious that the best choice is always to wait and see when facing a rapid increase in the price of houses or some other asset.