The experiences with the crisis and the decision to establish a macro-prudential stability function in Europe suggest that, even when building on existing structures, significant efforts are called for in order to extend and further improve models and tools. While it would be desirable for the risk assessment exercise to be increasingly quantitative, it should never become mechanistic or fully model-based. Expert judgement and qualitative assessments will always be crucial to understand the messages coming from various analytical tools, also taking into account overall intelligence efforts. Comprehensive information base Irrespective of their level of sophistication, models need to be fed with the appropriate data in order to produce results that, in addition to their analytical interest, can support policy messages. A comprehensive information base is also key in the risk surveillance phase that precedes the actual risk assessment. This is because the establishment of a wide radar screen supporting rigorous monitoring is only possible if the critical information is available. The current crisis has convincingly shown that a significant part of credit intermediation was channelled outside the banking sector and the regulated financial sector. The non-regulated or “shadow” banking system was almost totally off any surveillance radar screen. Not enough was known about special investment vehicles, conduits, securitisation markets and instruments, or about all the financial intermediation that takes place outside the traditional banking system. Moreover, little was known about the direct and indirect exposures between this shadow banking system and the regulated one, which turned out to be substantial.

[23] For instance, workers may accept some loss in real income as demand softens, costs can no longer be passed on easily to consumers and risks to job security increase. In some euro area countries, wage negotiations focus on core inflation rather than headline inflation. This can be seen as a recognition that the terms of trade loss has to be borne – at least to some extent – rather than retrieved. Also, in this setting, households may choose to reduce consumption – instead of smoothing it and mitigating the hit to spending – because a permanently lower potential output would also permanently reduce their future income and wealth. Recent research using endogenous growth models shows that, if supply shocks cause “scarring”, the prospect of lower potential output reduces investment and productivity growth. By compressing households’ future income and their current spending, it can cause demand to drop by as much as – or even more than – supply. [24] All told, these effects imply that, even in the face of lasting consequences of supply shocks on potential output, the implications for the output gap, inflation dynamics and optimal policy calibration can only be  derived over time. And this reinforces the case that, for as long as inflation expectations remain anchored, monetary policy should adjust but not overreact. [25] ECB staff projections published in September 2022, which foresee inflation close to 2% at the end of their horizon, are consistent with a withdrawal of monetary policy accommodation.