One example is when the Japanese central bank committed itself during a deflation crisis to keeping the policy rate at a low level during a certain period. For another example, see the press release from the Federal Reserve Board of Governors on 12 August 2003. 4  BIS Review 40/2007  levels we foresee two years ahead. And the focus should be on not only current interest rates, but also expectations of future interest rate changes 6 . …to market expectations… We left most of these problems behind us when we changed over in October 2005 to making forecasts based on market expectations of the future development of the policy rate. Compared with the assumption of an unchanged repo rate, market expectations normally provide a much more realistic forecast. This was one thing that made it easier to evaluate us. However, an assumption that the policy rate will develop in accordance with expectations in the financial markets has its disadvantages. This perhaps applies above all to the difficulties in communicating the interest rate path when market agents’ assessments differ substantially from those of the Riksbank. Another problem that could lead to a lack of clarity in communication is how market expectations of the development of the policy rate should actually be measured. It may be difficult to estimate and adjust for different premiums – the compensation for differences between securities with regard to the maturity, credit risk and degree of liquidity required by an investor. There are also different ways of doing it.
We are also aided by the fact that we are more reliant on traditional banking rather than the capital markets for our debt financing. Beyond the direct impact on banks, the general reduction in risk capital and financial deleveraging will be felt in Asia, through higher costs of capital. This is the downside that many companies and investors will have to confront. On the upside, this should further spur the efforts of Asian countries to make their own financial intermediation process more efficient. This can be done through a lowering of barriers to global capital and the building of channels to facilitate the growth of this capital. Global investors will increasingly look to Asia for investments as Asia remains an attractive area for growth in the long term. On the other hand, Asian companies will continue to require funds as they extend their global footprint. In this regard, lessons from the subprime crisis are timely. As Asian capital markets evolve, investors and risk managers alike will need to understand the innovations and the products as they develop. I believe that some key issues in the securitization markets will also have to be addressed, such as in origination standards. How investor confidence is restored will shape the ability of companies to tap capital market solutions in the near future. US recession and Asia’s growth story Let me now turn to the third issue, which is the impact of the US recession on Asia.