hold less genuine liquidity than they might otherwise. meanwhile, the amount of client funds being managed is much larger than it was and we don ’ t know how all those investors will behave in a more stressed environment, should one eventuate. a key concern the official sector has is that investors may be assuming a degree of liquidity that will not actually be available in a more stressed situation. putting all that together, we find a world where the banking system is much safer, but in capital markets some valuations are stretched, credit spreads are compressed, there has been significant cross - border capital flow and liquidity may be less available than investors are assuming. that raises the risk that a sell - off, were it to occur, could be abrupt. what might trigger such an event? the usual trigger people have in mind is a rise in us interest rates. the us economy now looks strong enough for the federal reserve to consider increasing its policy rate later in the year. in itself, this should be welcomed. and it will have been very well telegraphed. understandably, the fed is proceeding with the utmost caution. but it will also have been over nine years since the fed previously raised interest rates. some market participants won ’ t have lived through a fed tightening cycle before. hence, it would not be surprising to see some bumps along this road. a second trigger could come from slower growth in emerging markets. growth has already weakened in some economies, several of which have been bruised by falling commodity prices. capital that flowed into emerging markets could flow out again, perhaps when interest rates begin to rise in the united states. that would probably occur alongside an appreciating us dollar. so the distribution of credit risk and foreign currency risk will be of considerable importance. one can easily see why investors could become less forgiving of borrowers on a shaky footing, be they corporates or sovereigns. a complicating factor here is that the rise in us interest rates looks set to occur while the central banks of japan and europe are continuing an aggressive easing of monetary policy via balance sheet measures. the combined japanese and european “ qe ” will be very bis central bankers ’ speeches substantial. the extent to which such funds will flow across borders will depend on which sorts of investors are ‘ displaced ’ from their sovereign debt holdings and what their risk appetites are. to the extent that funds do flow across borders, the proportions in which they flow to emerging markets, as opposed to the united states

policy rates in the major advanced jurisdictions have been near zero for six years now. in fact, official deposit rates in the euro area and some other european countries are now negative. as it turns out, the “ zero lower bound ” wasn ’ t actually at zero. central bank balance sheets in the three large currency areas have expanded by a total of about us $ 5½ trillion since 2007, and the ecb and bank of japan will add, between them, about another us $ 2½ trillion to that over the next couple of years. that central banks have had to take such extraordinary measures speaks both to the severity of the crisis that these countries faced and the limited capacity of other policies to support growth. history tells us that recovering from a financial crisis is an especially long and painful process, and more so if other countries are in the same boat. the direct effect of this unprecedented monetary easing has been to lower whole yield curves to extraordinarily low levels, and that process is continuing. the most pronounced effects can be seen in europe. if one were to invest in german government debt for any duration short of nine years, one would be paying the german government to take one ’ s money. the same can be said for swiss government debt. even some corporate debt in europe has traded at negative yields. it seems likely that these european developments are also affecting long - term interest rates in the united states. these ultra - easy monetary policies have helped along the process of balance sheet repair, bringing households and businesses closer to the point where they can start to spend and hire and invest again. and, it has to be observed, it has made fiscal constraints on governments much less binding than they would otherwise have been. lower interest rates also increase the value of assets that can be used as collateral. banks ’ willingness to supply credit is affected by their balance sheet ’ s strength, of course, but it seems to be improving even in europe at present. for larger businesses with access to capital markets, borrowing terms have probably never been more favourable. such policies are, then, working through the channels available to them to support demand. but these channels are financial in nature. they don ’ t directly create demand in the way that, for example, government fiscal actions do. they work on the incentives for private savers, borrowers and investors to alter their financial behaviour and, it is hoped in time, their spending behaviour. a striking feature of the global economy, according to world bank and oecd