large rebounds in risk premia that i have noted in my charts. spreads on financial institution debt, in particular, have widened in the euro area and in the us reflecting uncertainty over the extent of future credit write - offs, the full recognition of offbalance - sheet commitments, and future earnings capacity. the wide perception in the markets is that financial institutions face difficulties in maintaining earnings due to falling credit quality and declining fee income in a macro - economic environment already taxed by sharp rises in real production costs. as intermediaries tend to economise on capital, assets are being sold and lending conditions have tightened. as i have shown in figure 3, the correction in the appraisal of risk has thus been broad - based, and spreads on funding costs for corporates have stuck to levels that had not been on market records for a long period of time. my conjecture is that the recent corrections and retrenchments in financial markets bring two lessons and leave much to be learned from future analysis and experience. i start from the two lessons. • first, as has often happened in the past, non - fundamental market dynamics have grown out of fundamentals and the feed - back loops that these have created. as i said already, increased financial market participation has set a new secular trend toward a lower price of risk sustained by long - term financial deepening. financial deepening, in turn, has initially responded to a real demand for a more efficient sharing of risk. more effective risk sharing has meant better mechanisms through which producers and ultimate savers can hedge open positions arising from their real transactions. as a side - effect, this process – generalised to a wide range of markets – has brought sustained capital gains to an expanding number of beneficiaries. this, in turn, has improved incomes and the economic outlook. and the process has been feeding and reinforcing itself. • second lesson : “ good health is always a precarious situation that does not presage anything good. ” at some point in the maturing process, brighter prospects have meant under - assessment of the macroeconomic risk and under - pricing of the unit quantity of risk. financial markets have ceased to facilitate the dispersion of the risk that is intrinsic to the underlying economic activities, and they have developed into formidable risk multipliers. the new structured financial products that grew exponentially in the ten years leading up to the recent disorders in financial markets, by pooling and repackaging income streams of

of countries which follow a stable exchange rate policy vis - a - vis the us dollar – was found to have played little or no role as a factor contributing to low long - term interest rates in a study of the interest rate conundrum. see rudebusch, swanson and wu ( 2006 ). the level of inflation is found to be correlated with its variability, which in turn should influence people ’ s perceptions of the degree of uncertainty that surrounds their macroeconomic environments. in many standard asset - pricing models with complete markets, the risk premium, or excess return, paid by an asset with uncertain payoffs is proportional to the volatility of consumption, with a risk aversion parameter as the constant of proportionality. in these models, aggregate consumption volatility stands for the quantity of risk, while the parameter scaling agents ’ risk aversion stands for the price of risk. a crucial subsidiary assumption behind this logic is that all wealth – including human capital – is tradable, so that the aggregate return can be interpreted as the gross return to an asset that represents a claim to aggregate consumption. the drawn - out moderation in real macroeconomic volatilities – the great moderation – is a well - known fact. it has been persistent, as the pictures indicate, and broad, spreading beyond inflation and consumption to virtually all sectors and components of income, on a global scale, as many studies have demonstrated. 6 the tight correlation between the risk premia priced in various markets and movements in macroeconomic risk is less known, however. it is certainly of great interest to policymakers. 7 it is a challenging piece of evidence for two reasons. because causation can run both ways, from macroeconomic volatility – the quantum of non - diversifiable risk – to risk compensation in the financial markets, or from the market determination of the reward for risk – the market price of risk – back to the macroeconomic equilibrium. and because both chains of causation entail a blend of structural and contingent factors : factors that are likely to last and factors that are transient and bound to be reversed. therefore, in september 2008 a scholar, a forecaster, a policymaker looking back to the financial history of the last quarter of a century for clues about the proximate future evolutions faces two questions. first, what determined the compression of risk in virtually all markets : was it a reduction in aggregate risk, or was it a compression in the price