Although some banks were recapitalized in 1999, the full regulatory response took several more years. The monetary and fiscal stimulus that was provided helped Japan avoid a deep recession. But expectations about future nominal income growth for both households and businesses ground lower over time. With inflation expectations sinking, inflation-adjusted real interest rates rose, and Japan became mired in deflation. While deflation is ultimately a monetary phenomenon, structural elements were also important. Long-term demographic factors added to the deflationary pressures and structural rigidities, and credit supply problems constrained the reallocation of resources to growth sectors. These structural factors made it substantially more difficult to escape the deflation trap. The Bank of Japan was active during this period. From the late 1990s onwards, it pioneered an extremely broad array of innovative tools – many of which were later adopted, in amended form, by the Fed and other major central banks. These included forward guidance on the future path of the policy rate, quantitative easing through purchases of government securities and private assets including asset-backed securities, equities and real estate investment trusts (REITs), a more quantitative inflation objective, and funding for bank lending. 2  Actual overnight rates; the Bank of Japan did not publish its rate target until 1998. 3  See “Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” Alan Ahearn, Joseph Gagnon, Jane Haltmaier, and Steve Kamin et. al., International Finance Discussion Papers, No 729, June 2002, Board of Governors of the Federal Reserve System.

One issue is the increasing integration of banking, securities and insurance services; a second is the increasing pace at which capital moves across international borders; a third, the Year 2000 problem; and a fourth, the challenge of bringing improved risk management techniques to business operations as a whole, including the trading rooms. This is particularly important for participants in the rapidly changing fixedincome markets. First, the integration of previously separate financial services means that institutions must be prepared to manage risks across a far wider range of products, business units, and counterparties than they have been accustomed to doing. In the securities lending markets, for example, an increasing number of firms are accepting equities as collateral for financing arrangements, or structuring securities lending transactions off-balance-sheet through total return swaps and other derivative structures. Thus, corporate treasurers must develop greater expertise in equity and derivatives markets. More broadly, the potential economies of scale and scope, as well as the potential benefits of reducing risk through sectoral and geographic diversification, have fueled the trend towards consolidation in varied financial industry sectors. As this trend continues, we must meet the challenge of merging the risk management practices of previously separate financial firms. These readjustments are likely to be far more complex for firms consolidating across the spectrum of financial service providers. A second issue that has an important bearing on risk management techniques is the increasing pace at which capital moves across international borders.