We hope to conclude this review by the end of the year. One important element in our discussion is the amount of central bank reserves required to effectively steer short-term interest rates in either a floor or a corridor system. This amount informs our decisionmaking as to when balance sheet normalisation might need to be halted. Structural and regulatory changes have made estimating the demand for reserves more challenging than before the global financial crisis. [5] However, our current estimates suggest that the amount of central bank reserves currently held by the banking sector exceeds, by a significant margin, the level necessary to steer short-term market rates close to our key policy rate even under a floor system. This implies that the current size of our balance sheet is larger than necessary to effectively implement our monetary policy stance. As such, maintaining a large bond portfolio absorbs valuable policy space that may be needed if policy rates were to become constrained again by the effective lower bound. Shrinking the balance sheet, to the extent possible, is therefore both prudent and efficient. Mitigating negative side effects of a large balance sheet The second reason for reducing the APP portfolio is related to the side effects of running a large balance sheet. It is well documented that bond purchases can cause asset price valuations in financial and real estate markets to diverge from their economic fundamentals, thus raising both financial stability risks and wealth inequality. [6] Maintaining too large a balance sheet may also have undesirable side effects.

Norway is part of the European Economic Area, and EU regulations are thus applicable in this country. Within the remaining national discretion, Norwegian regulations are laid down by the Ministry of Finance, and implemented by the Financial Supervisory Authority. But Norges Bank aims to be an active advisor on these issues. Our work on macroprudential supervision provides insights that we wish to share with other supervisory authorities. The second component of macroprudential policies consists of short and medium term measures to alleviate the effects from the procyclical behaviour of financial institutions. There are two macroprudential aspect of procyclicality. It is the common exposures of a group of  BIS Review 112/2010  1  financial institutions. And it is the interconnectivity of financial institutions through trading and credit relationships. Common exposures are probably the most important of these interdependencies for crisis generation. Individual institutions can look perfectly healthy even when vulnerabilities are building up on the systemic level. The prime example of this phenomenon is naturally lending stimulating a price bubble in the property market. Developing time-varying macroprudential policies is not straightforward. The interest rate policy targets the inflation rate, and cannot always be set as would be appropriate for asset prices. There might be conflicting targets. We should thus be looking for new instruments. As you are certainly aware, most of the macroprudential policy instruments that have been proposed are the same as those already being used for microprudential purposes.