, we have moved from a situation where credit was price - controlled and quantity - rationed, to one where credit availability is market determined. it is probably fair to say that the credit expansions that followed this shift around the world were larger and more bis central bankers ’ speeches protracted than many had expected. nonetheless, it was by nature a one - time adjustment, and one that has probably now run its course. another factor in the one - off category is the transition to low inflation and the consequent fall in nominal interest rates. in the late 1980s, mortgage interest rates in australia reached a now unimaginable 17 per cent. although that peak was partly cyclical, it also partly reflected the inflation premium built into the interest rate structure. as inflation expectations and nominal interest rates came down in the 1990s, there was a corresponding increase in the average household ’ s capacity to borrow. as a simple illustrative calculation, if we assume a debt service ratio of 30 per cent on a standard 25 year mortgage, a household ’ s borrowing capacity would have gone from around two times annual income in the late 1980s to something like four times income a decade and a half later. taken in combination with the removal of regulatory constraints on credit supply, this would go a long way towards explaining the quarter - century rise in household debt ratios. 1 the adjustment to this new reality seems to have been spread over a fairly lengthy period of time. but again, with inflation having been low and stable for more than two decades now, it can be seen as essentially a one - off factor that has probably run its course. my third category of forces are those associated with the cyclical dynamics of credit and asset prices. the financial sector has a well - documented capacity to engage in bouts of overexpansion, driven by self - reinforcing expectations and followed by periods of readjustment and consolidation. credit cycles of this nature can be unpredictable in duration, ranging from the short and sharp to longer episodes spanning a decade or more. but we can think of these dynamics as being superimposed on the longer - term forces that i ’ ve already described. even though these forces might be conceptually distinct, they are in practice likely to be highly interconnected. a financial bubble doesn ’ t usually come out of nowhere. typically it starts as a well - based reaction to some genuinely new event, but then develops a selffulfilling momentum of its own, often with elements of irrespon

is the latin for “ i trust ”, from which we get fiduciary and fidelity. 1 so credit is fundamentally an issue of trust. without trust, we don ’ t have credit. that lack of credit is a phenomenon which is playing out in a number of countries around the world at the moment, again, thankfully, not here in australia. the lack of trust is contributing to the unwillingness of financial institutions to extend credit and the difficulty some governments are having in obtaining funding. in turn, the lack of credit growth is exerting a major restraint on the economic recoveries in a number of countries around the world. in the post - war period, easier monetary policy has invariably helped foster a rebound in economic growth following a recession. an important transmission channel for monetary policy to take effect has almost always been a pick - up in lending to businesses and households. that is clearly not happening in many countries at the moment. central banks in those countries are reaching deep into their toolkits to revive lending and foster economic recovery. but the lack of trust is significantly curtailing the ability of the normal implementation of macropolicy tools, both monetary and fiscal, to engender a sustainable economic recovery. my high school latin teachers will be pleased to see some return, if a few decades after the fact, from their efforts. bis central bankers ’ speeches the outline of my talk is to firstly discuss the role that the financial sector plays in the economy. then i will examine the crucial role that trust plays in financial intermediation and in ensuring the financial system runs smoothly. following that, i will document the breakdown of trust that has occurred over the past five years. to finish on a more positive note, i will outline some of the avenues that might be taken to restore trust in the financial system. some of these themes were addressed in a speech entitled “ credit is trust ” delivered by my colleague at the bank of england, andy haldane, in september 2009. 2 andy highlighted the reduction in trust that had taken place in the previous two years – what was then the first two years of the financial crisis. but three years on from 2009, the situation is even worse. the lack of trust in the financial system has intensified. distrust has spread beyond the finance system to other institutions. this is particularly evident in europe, where there is a lack of trust in some quarters in the longevity of the euro, and a lack of trust by bondholders of some european governments that