This approach will allow us time to assess how the economy is performing under less accommodative financial conditions and reduce the odds of overaggressive rate hikes choking off progress toward our policy goals. History shows that premature exit is a risk Past experience with the ZLB also counsels patience. History has not looked kindly on attempts to prematurely remove monetary accommodation from economies that are in or near a liquidity trap. Three occasions come readily to mind: the Great Depression (which was resolved only with the massive fiscal expansion of World War II), Japan over the past 20 years, and the recent European experience. Indeed, both of the more recent episodes are ongoing today, though Japan finally appears to be making important headway toward raising inflation and eventually exiting the ZLB. The U.S., Japanese and European lessons from monetary history strongly suggest that there are great risks to premature liftoff from the ZLB or near-ZLB conditions. Unless the economy is fundamentally strong and the previous impediments to growth have receded sufficiently, the odds remain high that some unforeseen shock could cause the monetary authority to retreat right back into the ZLB. And the costs of being mired in the ZLB are simply very large. The ZLB prevents using our very best policy tools to address negative shocks. The ZLB means that interest rates cannot fall low enough to equate the supply of saving with the demand for investment, which, of course, significantly impedes capital formation, future economic growth, and the health of labor markets.

With respect to size, an overly large financial system could have negative effects on the functioning of the economy, either because it drains too many  1  I would like to thank Simone Manganelli for his valuable input. 2  Volckart, Oliver and Nikolaus Wolf (2006). Estimating Financial Integration in the Middle Ages: What can we learn from a TAR-model?, Journal of Economic History 66, 1, 122–139, Late medieval financial market integration: the Hanseatic Area, the Holy Roman Empire and the Kingdom of Poland, c. 1300–1550, research project proposal by O. Volckart, London School of Economics. BIS Review 81/2010  1  resources from other sectors, or because it increases the risks of bubbles. I will conclude with a few considerations on how the establishment of the European Systemic Risk Board can contribute to enhance the stability of our financial system. 1. Financial integration: an irreversible process  In my view, three elements constitute an integrated financial market: (i) a single set of rules, (ii) equal access to financial instruments or services, and (iii) equal treatment in operating in the market. If these conditions are satisfied, any price difference between assets with identical risk-return characteristics will be immediately arbitraged away. This definition stems from the intuition that lack of integration reflects the existence of barriers to cross-border activities. One can think of three main categories of obstacles to financial integration: cultural, legal and technical. Recent academic research has shown that there are non-negligible psychological and cultural barriers to financial integration.