5 The situation had long required bold institutional reforms to the design of monetary union and we should praise the European Commission for having quickly prepared proposals for a Banking Union in 2012. The banking union must be instrumental in resolving the crisis In my view, the banking union must be instrumental in resolving the crisis and unravelling its legacy. It is the crucial node to secure both financial integration and stability. The reason is clear. In the euro area, about 75% of the real economy’s financing needs still originate from the banking sector. What is more, banks are crucial counterparties in the broader system of financial intermediation. Therefore, the importance of establishing the Single Supervisory Mechanism and creating a level playing field for all banks across Europe cannot be overemphasized. 6 A relevant part of this endeavour is the Comprehensive Assessment of bank´s balancesheets that will precede the beginning of the supervisory tasks by the ECB/SSM. Aiming at completing the balance-sheet repair of the banks subject to the SSM it will improve their capital and solvency position. In spite of the recent credit negative behaviour being mostly the result of lack of demand, the enhanced robustness of banks will overcome remaining credit supply restrictions that could hamper the recovery. This process of repairing the banking system is only one part of the challenge policymakers face in Europe. The other, more fundamental part is to build a safer and more resilient financial sector that serves the real economy.

In addition, the damage from the sharp stock market decline was mitigated by the Federal Reserve’s commitment “to serve as a source of liquidity to support the economic and financial system.”5 A contrasting example is the sharp appreciation of the dollar that began in 1978 and reached a peak in March 1985. The persistent strength of the dollar had a significant negative consequence for U.S. trade performance. Our trade deficit widened sharply in 1985 and 1986, which contributed to the sharp slowdown in U.S. manufacturing production growth—and a milder slowdown in GDP growth—over this period. This leads to an important question: When should the FOMC take changes in financial conditions into consideration in its conduct of monetary policy? I don’t think there is a simple answer. Financial conditions matter in influencing the economic outlook, but so do many other factors. It is true that monitoring financial conditions can help improve the effectiveness of the policy decision-making process. However, as I hope is clear from my previous examples, there is no mechanical link between policy rates and financial conditions that monetary policymakers can systematically rely upon to set policy. Another key question is what one should focus on in assessing financial conditions. Again, I don’t think there is a simple answer, as the significance of any particular aspect of changes in financial conditions depends on the economic circumstances and environment. In the early- to mid-2000s, the combination of looser mortgage underwriting practices and home equity withdrawal were major financial factors contributing to that economic expansion.