A stable financial system ensures that changes in the monetary policy instrument have the intended effects on market rates. Hence changes in monetary policy will affect the behaviour of consumers and enterprises and, eventually, inflation and economic activity. Moreover, price stability has a positive influence on financial stability. A successful monetary policy will support financial stability by removing distorted price signals associated with high and volatile inflation. Low and stable inflation provides households and enterprises with a clear indication of changes in relative prices. Allocation of resources will then be more effective. It is easy to identify situations where the objectives of price stability and financial stability imply the same medicine. For instance, expansionary periods are often accompanied by stronger inflationary pressures and asset price increases, both implying a need for tighter monetary policy. There are, however, examples of situations where the consideration is more complex. As the chart illustrates, surges in asset prices and a low and stable general price level of goods and services can appear simultaneously. There can be several reasons for this. First, a highly credible monetary policy results in low inflation expectations among economic agents. Explicit or implicit long-term price and wage contracts can be more common. It may then take more time for higher demand to translate into higher inflation. Asset prices on the other hand, will not be constrained by expectations such as those for consumer prices and may well react strongly to changing economic activity.

Svein Gjedrem: The macroprudential approach to financial stability Keynote address by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), at the conference entitled “Monetary Policy and Financial Stability”, hosted by the Oesterreichische Nationalbank (Austrian National Bank), Vienna, 12 May 2005. Please note that the text below may differ slightly from the actual presentation. The  Charts in pdf-format can be found on the Norges Bank’s website. *  *  *  Introduction First of all I would like to thank the organisers for inviting me to this conference. It’s a great pleasure to be given the opportunity to share with you some views on financial stability issues. Financial stability has become an increasingly important objective in economic policymaking during recent decades. In the 1980s, direct regulation of credit markets and capital flows was dismantled in many countries. This has prepared the ground for an expansion of the financial system at a faster pace than other parts of the economy. In this process, the financial system has gone through important structural changes and become more complex. The instruments have become more intricate, the activities more diversified and the risks more mobile. As a result of increasing cross-industry and cross-border integration, financial systems have also become more interwoven, both nationally and internationally. In parallel with the strong growth of the financial system, we have seen more frequent instances of widespread financial distress. The resulting macroeconomic costs have often been sizeable.