Instead, it is argued, monetary policy should be aimed at attempting to counteract financial imbalances to a greater degree, possibly even exclusively. In relation to this debate, Sweden finds itself in a rather unique position. We have discussed these issues for longer than most other countries, we have experience of a policy that was aimed, to a certain extent, at counteracting financial imbalances, inflation fell earlier in Sweden than in many other areas, and we have also – after a long period of highly expansionary monetary policy – managed to bring it back on target. In other words, we have a number of experiences to share. Here, I have given an account of what I consider have been the most important experiences: that it is important not to lose sight of inflation and inflation expectations, that it may take significant interest rate rises to halt the accumulation of financial imbalances and that it may take a long period of highly expansionary policies to bring inflation up – but that it is possible to bring it up. In conclusion, to avoid misunderstandings, I would like to emphasise that my comments today do not, in any way, mean that I consider that central banks should not have any role or responsibility for financial stability. That issue deals with much more than whether or not it is appropriate to address financial imbalances with monetary policy and the policy rate.
And the Basel Committee is developing the capital framework to ensure implicit offers of contingent support by banks, for example to their SIVs, will be properly capitalised. Interconnections created by derivatives are being reduced and made transparent. Requirements are being imposed, and incentives created, for banks to centrally clear derivative trades, helping to replace the complex web of bilateral deals with a central model. Trade reporting and margining requirements are being strengthened. More broadly, overall disclosure has been enhanced on the key risks arising from business models, sources of funding, market risk measures and loan forbearance policies.5 Through such initiatives, complexity and obscurity are being replaced by simplicity and transparency. A fairer financial system That goes some way towards increasing the effectiveness of market discipline. But that discipline will never be felt fully if markets believe that creditors and shareholders will be bailed out in a crisis because banks are too big to fail. Expectation of bail out was validated comprehensively last time. The US authorities sought to make Lehman Brothers a test case of moral hazard. Instead, this exception proved the rule. AIG was rescued within twenty four hours. As Barney Frank observed, the free market lasted for a day. This “heads-I-win-tails-you-lose” environment for the world’s largest banks struck right at the heart of the sense of fairness in our societies. It simply had to be fixed. Tackling the rampant moral hazard at the core of the system has not been easy but, at the Brisbane Summit, G20 Leaders marked a watershed in our efforts.