One striking consequence of these macro imbalances was the financing of the private spending in rich countries by households in relatively poor emerging economies. To put it another way, excessive reserves accumulated in emerging economies through high current account surpluses flowed back to financial markets of advanced economies, which enabled households in these countries borrow beyond their means. Despite rapid growing domestic demand and acceleration of commodity prices, global inflation remained subdued for a considerable period of time since surplus countries kept their labor cost under control to sustain their competitiveness in global markets. Therefore, price stability oriented central banks in advanced economies saw no reason for a strong monetary tightening and stayed idle as their economies dangerously overheated. Second reason for the global crisis was the unprecedented amount of liquidity created in the global financial system. Innovations in financial engineering and technological advances facilitated the emergence of new and complex financial products, which in turn led to a massive growth in liquidity in advanced economies, well beyond the intention or control of central banks. High leverage ratios in financial institutions also played a significant role, thanks to creative accounting practices and lax regulations. Ample global liquidity coupled with low interest rates and excessive rise in asset prices fueled the rapid growth in the indebtedness of households. As a final element, the institutions responsible for regulation and supervision of financial institutions failed to keep up with the extremely innovative, deep and complex nature of the financial markets.

There are also calls for establishing new global mechanisms to address the concerns of emerging market economies regarding FX liquidity, which has led to accumulation of high amount of FX reserves through capital controls and intervention on exchange rates to keep local currency undervalued. Of course, relaxing capital controls and gradual adoption of more flexible exchange rate systems should also be part of this package to achieve successful reorientation of global demand from advanced economies to emerging market economies. Last but not least, all countries should undertake necessary actions to repair, restructure and reform their financial system. Necessary structural reforms in product and labor market should also be a top priority to increase potential growth rates and reduce permanent unemployment. Dear Guests, Now let me turn to responsibilities of central banks and elaborate on their evolution over time. Until recently when you asked the primary mandate of central banks, the typical response would be price stability. However, the history tells us that central banks were founded for quite different reasons in many countries. For instance the Bank of England was founded in the 17th century to cover the financing need of the British Government during its war against France. Likewise, Bank de France was created in the 19th century during the Napoleon Wars against the Great Britain. These institutions had the privilege of issuing banknotes in  2  BIS Review 73/2010  exchange for providing funds for treasuries. In other countries providing stability in financial markets was the paramount concern.