is the approach that the fed unsuccessfully tried to name “ credit easing ” – actions directed at reviving particular markets whose difficulties were creating major problems in the financial system. for instance, when the commercial paper market in the united states was collapsing, the fed entered on a major scale as a purchaser, and succeeded in reviving the market. similarly it played a significant role in keeping the mortgage market alive. in this regard the fed became the market maker of last resort. 5 in a well - known article, james tobin in 19636 asked in which assets the central bank should conduct open market operations. his answer was the market for capital – namely the stock market – since that way it could have the most direct effect on the cost of capital, later known as tobin ’ s q, which he saw as the main price through which the central bank could affect economic activity. although central banks have occasionally operated in the stock market – most notably the hong kong monetary authority in 1997 – this has not yet become an accepted way of conducting monetary policy. 7 lesson 2 : the critical importance of having a strong and robust financial system this is a lesson that we have all thought we understood for a long time – not least since the financial crises of the 1990s – but whose central importance has been reaffirmed by the recent global crisis. this crisis has been far worse in many of the advanced countries – among them the united states, the united kingdom, and some other european countries – than it has been in the leading emerging market countries. this was not the situation in the financial crises of the 1990s, and it is not a situation that i expected would ever occur. the critical difference between countries that have suffered from exceptionally deep crises and those that had a more or less standard business cycle experience during this crisis jan hatzius, “ the specter of deflation ”, in us economics analyst – goldman sachs global ecs research, march 2009. this term was introduced into the literature by willem buiter and anne siebert. james tobin, “ an essay on the principles of debt management ”, in his essays in economics, volume i, macroeconomics, markham publishers ( chicago ), 1971. it is sometimes objected that such actions would require excessively detailed intervention by the central bank, since it would have to decide which companies'assets to buy. however it could simply buy very broad stock indices. bis central bankers ’ speeches traces to what happened in their financial sectors. those countries that suffered financial sector crises

had much deeper output crises. in their important book, this time is different, carmen reinhart and ken rogoff8 document the fact that over many centuries, downturns that also involved a financial crisis were more severe than those that did not. this is not coincidental, for the collapse of the financial system not only reduces the efficiency of financial intermediation but also has a critical effect on the monetary transmission mechanism and thus on the ability of the central bank to mitigate the real effects of the crisis. if the financial system is intact, the standard anti - cyclical monetary policy response of cutting interest rates produces its response in the encouragement of purchases of durables, ranging from investment goods and housing to consumer durables. this happened during this crisis, in that many countries that did not suffer from a financial crisis but had cut interest rates sharply to deal with the negative effects of the global crisis returned to growth more rapidly than other countries, and soon found asset prices, particularly the price of housing, rising rapidly. among these countries are australia, canada, china, israel, korea, norway and singapore. the next question is what needs to be done to maintain a strong and robust financial system. some of the answers to this question are to be found in the blizzard of recommendations for financial sector and regulatory reform coming out of the basel committee – now extended to include all the g - 20 countries plus a few more – and the financial stability board ( the fsb ). in particular the recommendations relate to the capital requirements of the banks, which the basel committee and the fsb recommend raising sharply, including by toughening the requirements for assets to qualify as tier 1 and tier 2 capital. in addition, there are recommendations on the structure of incentives, on corporate governance, on the advisability of countercyclical capital requirements, on risk management, on resolution mechanisms including eventually on how to resolve a sifi ( systemically important financial institution, typically a bank with major international operations ) – and much more. 9 further, there has been a focus on systemic supervision and its organization, a topic to which we will return shortly. these recommendations make sense, and the main question relating to them is whether and how they will be implemented, and whether political pressures will either prevent their implementation and / or lead to their gradual weakening. there is already cause for concern in that some of the recommendations are to be implemented only by 2019 – a period sufficiently long for everyone to forget why such drastic changes are