IS is an aggregate demand schedule, with demand a decreasing function of both the policy rate, R, and a macroprudential instrument, K. PC is an expectations-augmented Phillips curve, in which inflation expectations are assumed to be anchored at the inflation target. 6 For any given set of shocks to aggregate demand and supply, the inflation target can be achieved by the set of pairs of R and K along the downward sloping schedule PS (for Price Stability) in the righthand diagram. An increase in demand resulting from, say, an increase in the propensity to invest, would shift this schedule out to the right. 6  6  In the literature, credit frictions and macroprudential policies can also affect potential output; see for instance Vasco Cúrdia and Michael Woodford (2010), “Credit spreads and monetary policy.” Journal of Money, Credit and Banking 42(S1), pp3–35. For simplicity of exposition, I abstract from such effects here. BIS central bankers’ speeches  Turn now to the credit market. Conventional macroeconomic analyses of the market for loanable funds tend to focus on the flow of funds from saving households to businesses undertaking capital expenditures. But, as Chart 9 makes clear, such lending constitutes only a small fraction of the assets held by UK banks. The vast majority of loans are instead provided to finance the acquisition of existing assets, especially real estate. This should be borne in mind when contemplating the factors behind the demand and supply of credit, shown in the left-hand panel of Chart 10 as CD and CS respectively.

A more detailed answer to the causes of changes in the degree of impact of individual factors on money supply growth can be found when studying their development in different periods of the transformation. In Czechoslovakia, during the first transformation years (1990-1992) money supply growth was based primarily on the relatively quickly increasing volume of credits granted to enterprises due to growing credit demand, which was very closely connected with the BIS Review 25/1997  -9-  liberalisation of entrepreneurial activities in a newly created market environment (an increasing number of businesses in need of initial capital). Gradually, foreign money creation also expanded, affected by the development of an improving balance of payments, particularly the current account. The gradual stabilisation of the macroeconomic and political environment (apparent mainly after the dissolution of the Czechoslovak Federation in January, 1993, and the relatively rapid calming of price developments following the introduction of a new tax system based on value added tax), the commencement of the activities of capital market institutions and the stability of the exchange rate which significantly decreased the risks for foreign investors, led in the second half of 1993 to a significant strengthening of the influence of the inflow of foreign funds into the Czech Republic on money supply growth. The strong foreign capital inflows continued to influence money supply growth in 1994 and 1995 when capital inflows reached 18 per cent of GDP. This growth was particularly generated by increasing foreign direct investments, portfolio investments and relatively cheaper foreign credits drawn by domestic enterprises.