As you may remember, at that time governments and central banks stood back as the private demand collapsed, leading to a downward spiral in the world economy, “beggar-your-neighbor” type of economic policies and protectionism that prolonged the depression well into the 1940s. We did not repeat the same mistakes, but maybe we have committed in new ones. Fiscal stimulus packages and bailouts of financial institutions have caused budget deficits of epic proportions, skyrocketing the public debt ratios. The events of the last few weeks have demonstrated that governments, especially in advanced economies, face the risk of contagion of the financial crisis to public finances in the form of sovereign default. In other words, the global crisis, which started as a financial crisis in mid 2007 has evolved into a sovereign debt crisis in 2010. Today, there is a consensus among policy makers that in order to put the global growth on a strong, sustainable and balanced path, high debt economies should implement fiscal consolidation, which is both financially ambitious and politically feasible, while countries with low debt should implement policies that stimulate domestic consumption to offset the fall in global demand. One fundamental reason of high savings rate in developing countries is the weakness of safety nets (in employment, retirement and healthcare) and the lack of well-established financial institutions that serve the needs of households facing budget constraints. If safety nets and credit markets in developing countries were established, households would be able to raise their consumption.

However, over time as the financial system get more complicated and expanded exponentially, its supervision and regulation has been partially transferred to other institutions, which is also the case in Turkey. The challenge faced by central banks is to establish a framework that combines both price stability and financial stability as primary mandates even at times they conflict with each other and identify the policy instruments to target both. As you know central banks have typically used short-term interest rates as their primary policy instrument. However, the “Tinbergen Rule” suggests that this one instrument could be deployed to achieve only one target, which is conventionally recognized as price stability. Addressing both price stability and financial stability simultaneously necessitates a second set of policy tools. This second instrument may be in the form of the supervision and regulation of financial activities. The question is that whether these responsibilities should be assumed solely by central banks. The downside of this option is that central banks may turn out to be too big, inflexible and in conflict with themselves, which eventually led to failure in both objectives. Dear Participants, Prior to the global financial crisis, central banks were conducting monetary policy through conventional banks and use government bonds in open market operations. However the  BIS Review 73/2010  3  financial crisis led central banks employ a wider range of securities, ranging from corporate bonds to asset backed securities and mortgages. The reason behind this transformation was obvious.