The high level of indebtedness built up during the economic upturn in many countries significantly increased this risk. Positive expectations of the future had increased companies' financing needs for investment. At the same time, a bright picture painted of the future and an increase in wealth had stimulated households' consumption and increased their investment in housing. It was easy to imagine a risk scenario where household sector demand declined so rapidly that heavily indebted companies went bankrupt, where unemployment rose drastically and where banks an other lenders suffered extensive loan losses. This negative spiral could continue with further falls in share prices and household wealth and rising credit risk premiums would make lending more expensive. If this negative sequence of events were not broken, high loan losses could eventually lead to bank crises and credit crunches, which would contribute further to the downward spiral. A credit boom, large increases in asset prices and a high rate of growth in investment, often concentrated on a particular sector, have been the factors preceding serious financial crises around the world. However, it is important to remember that neither a credit boom nor a large deficit on the current account need be interpreted as an accumulation of financial imbalances. If savings and investment decisions are based on realistic expectations of future growth and banks and financial investors have been able to make realistic assessments of the credit risks connected with investment projects and consumption loans, then this development is more a sign that the international capital markets are functioning efficiently.

Banks and other financial institutions drastically reduced their exposure to the risks that they had imprudently accumulated during the phase of financial euphoria. Financial intermediation and loans to companies were curtailed in the wake of a forceful process of “deleveraging”. This was the point when important spillovers of the financial crisis set in. We saw the almost immediate spillover from the financial sector to the real economy. The credit squeeze and loss of confidence started to take a toll on the real economy, and a negative feedback loop developed between the financial sector and the real economy, and has since become a major feature of economic and financial developments. Almost simultaneously, the crisis that originated in the advanced economies spilled over to the emerging market economies. Since the fourth quarter of 2008, virtually all economies – both those of the industrialised countries and the emerging markets – have faced synchronised business cycles. Since half a year, we are facing a highly synchronised global economic downturn. The ECB’s response to the financial crisis Turning to the ECB’s response to the crisis, let me first insist that none of my remarks should be interpreted in terms of the future course of monetary policy. I stick rigorously to what I have said during my last press conference. We are indeed in the one-week “purdah period” before the next meeting of the Governing Council. Since the start of the financial turmoil, central banks around the globe face unprecedented challenges.