Once the investors in these financing arrangements – many conservatively managed money funds – withdrew or threatened to withdraw their funds from these markets, the system became vulnerable to a self-reinforcing cycle of forced liquidation of assets, which further increased volatility and lowered prices across a variety of asset classes. In response, margin requirements were increased, or financing was withdrawn altogether from some customers, forcing more de-leveraging. Capital cushions eroded as assets were sold into distressed markets. The force of this dynamic was exacerbated by the poor quality of assets – particularly mortgage-related assets – that had been spread across the system. This helps explain how a relatively small quantity of risky assets was able to undermine the confidence of investors and other market participants across a much broader range of assets and markets. Banks could not fully absorb and offset the effects of the pullback in investor participation – or the "run" – on this non-bank system, in part because they themselves had sponsored many of these off-balance-sheet vehicles. They had written very large contingent commitments to provide liquidity support to many of the funding vehicles that were under pressure. They had retained substantial economic exposure to the risk of a deterioration in house prices and to a broader economic downturn, and as a result, many suffered a sharp increase in their cost of borrowing. The funding and balance sheet pressures on banks were intensified by the rapid breakdown of securitization and structured finance markets.

These include the slope of the Phillips Curve, central bank’s policy responses together with the constraints imposed by elevated public debt levels, and importantly, agents’ expectations. Expectations in Macroeconomics 12. This brings me to my second set of comments. One of the truly revolutionary developments in macroeconomic analysis has been the recognition that expectations are central to the behaviour of agents. Most of us would probably reach back to at least Keynes’ General Theory, as marking its formal induction into general equilibrium macroeconomics. The theory and practice of macroeconomic expectations has evolved quite rapidly since then. In particular, Robert Shiller and George Akerlof were key figures in formalising the idea that changes in expectations may manifest as exogenous shocks rather than factor in endogenously as posited by the theory of rational expectations, thus giving analytical form to Keynes' “animal spirits” in macroeconomic research. [3] 13. More recently, Shiller and Akerlof have also led a revival in the interest of expectations in economics [4] . Placing a modern contextualisation to “animal spirits”, they describe it as “a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity or uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.” I think we can quite easily relate to such descriptions. We have seen the importance of expectations in determining aggregate outcomes during crisis, as well as in specific markets and cycles.