of the shortfall in income since 2007 compared to its pre - 2007 trend ( brazier 2019 ). 2 for example, acemoglu and zilibotti ( 1997 ), arestis and demetriades ( 1997 ), and beck and levine ( 2004 ) provide evidence that the financial sector has a positive role on economic growth. 3 the ‘ efficient market hypothesis ’ was popularised by fama ( 1970 ). complete markets were theorised by arrow and debreu ( 1954 ). 4 for example, markets could be inefficient due to information asymmetries, transaction costs, market psychology, sticky prices, monopolistic competition, or credit constraints. 5 drehmann et al. ( 2012 ) and lang et al. ( 2020 ) highlight the importance of cyclical risk for financial stability. 6 glasserman and young ( 2015 ) and acemoglu et al. ( 2015 ) discuss the risk of contagion in the financial system. 7 woods ( 2022 ) discusses alternative approaches to buffer usability. 6 / 7 bis central bankers'speeches 8 see bank of england ( 2021 ). 9 see chatterjee ( 2022 ) for a comparison of the uk financial conditions index for the gfc and covid. 10 lloyd et al. ( 2021 ) shows that foreign shocks are a key driver of domestic macroeconomic tail risks. bluwstein et al. ( 2020 ) also show that global factors can predict financial crises. 11 see czech et al. ( 2021 ). 12 bank of england ( 2021 ) provides more details on vulnerabilities associated with market - based finance and liquidity mismatch in open - ended funds, in particular. 13 in q1 2022 financial stability in focus bank of england sets out the role of cryptoassets and defi in the financial system and identified potential risks associated with them. 14 breeden ( 2022 ) talks about the economy ’ s transition to net - zero, and the role central banks can play to support it. 7 / 7 bis central bankers'speeches

efficiently and effectively. similarly, micro - prudential policy ensures the safety and soundness of individual institutions, but does not take a sufficiently bird ’ s eye view to identify possible risks affecting the financial system as a whole. the financial crisis highlighted quite how much the whole is greater than the sum of its parts. and that ensuring the parts are healthy does not guarantee that the whole is. macro - prudential interventions typically fill two gaps : 1. individual agents don ’ t necessarily take into account the bigger picture. individual financial institutions and borrowers face private incentives which do not take into account the wider social impact of their actions. in such cases, macro - prudential policymakers can seek to better align private costs and benefits with social costs and benefits. one example is the financial policy committee ’ s ( fpc ) mortgage tools, which seek to limit the number of mortgages banks can extend for loans that are high relative to income. individual borrowers may be keen to stretch themselves financially to buy a bigger house, expecting their earnings to grow or house prices to rise. and individual lenders may be happy to provide a larger loan to receive more income. but should a recession hit, not only will we see defaults, but overstretched borrowers will reduce their spending as they struggle to pay their mortgages. and this reduction would ultimately spillover to the rest of the economy, making the downturn worse. macro - prudential policy takes these spillovers into account. by ensuring borrowers in aggregate are not overstretching themselves and financial institutions in general are lending responsibly, macro - prudential regulators can ensure that the whole system is more resilient to shocks. 2 / 7 bis central bankers'speeches 2. markets are not necessarily efficient or complete3. market prices may not reflect the real value of assets4, not every market is perfectly liquid and risks may not be as welldispersed as they might seem. these imperfections can lead to two types of risk to financial stability : cyclical and structural. cyclical risks arise because financial conditions can suddenly reverse. 5 the simplest example is of financial institutions taking on too much risk in booms, in the expectation that the assets they purchase will always be in demand. when the cycle turns, asset prices can fall rapidly, leaving institutions with losses. this is why we have countercyclical tools – to ensure the system can build up resilience in good times, and