bank steps in to provide liquidity as mmlr, market liquidity will not automatically improve. as a result, the central bank will face a difficult decision as to how far it is prepared to go. depending on its own actions as mmlr, not only will those actions affect the stability of the financial system and the effectiveness of monetary policy, but they will also endogenously influence the central bank ’ s own financial soundness. if the central bank ’ s actions as mmlr are able to set in motion a process of reviving market liquidity, the market prices of the assets that the central bank had purchased or accepted as collateral will stabilize, thus safeguarding its equity capital. if, in contrast, the central bank attempts to defend its balance sheet – and hence the confidence in the central bank – and limit its capital exposure by holding back on liquidity provision as mmlr, market liquidity might continue to decline, which would, in turn undermine the value of the assets that the central bank had purchased or accepted as collateral, eventually risking a hit to its equity capital. an erosion of the central bank ’ s financial soundness resulting in a loss of its credibility may compromise its ability to implement monetary policy and ultimately the effectiveness of such policy. in addition, losses incurred by the central bank would hurt taxpayers as transfers to the government are reduced and its actions as mmlr would inevitably impinge upon microlevel resource allocation, which implies that they are quasi - fiscal measures ( chart 4 ). at the same time, however, it is also undesirable to see the central bank not acting sufficiently forcefully as mmlr in order to minimize hits on its balance sheet. in this context, when the federal reserve introduced the term asset - backed securities loan facility so as to restore liquidity in the abs market, it was agreed that the u. s. government would shoulder losses up to a certain level. in the case of the asset purchase programme of the bank of england, this is based on the agreement that any losses will be borne by the u. k. government. in the case of the bank of japan, when it decided to embark on a program of purchasing corporate financing instruments in 2009, the japanese government noted at the monetary policy meeting that it intended to consult with the bank of japan in the context of closing its books at the end of accounting periods if the risks had materialized. the financial trilemma and cooperation among central banks with regard to the stability of the financial system

stefan ingves : introduction on monetary policy and financial stability speech by mr stefan ingves, governor of the sveriges riksbank, before the riksdag committee on finance, stockholm, 5 november 2009. * * * a little more than a year has passed since the financial crisis swept over the swedish economy with full force. a dramatic year, which, despite vigorous measures by central banks and other authorities around the world, has led to the worst economic recession for many decades. but now the economy is beginning to recover, although it will take time before we are on firm ground again. so where in the crisis cycle do we stand today? how should the riksbank act to attain the inflation target and to provide support to the economic recovery in the best possible manner? it appears as though the swedish economy will land on its feet on this occasion, but it is also necessary to keep our balance in the future. this is in many ways a global challenge and a process of change, in which sweden should play an active role. when we met here at the committee on finance hearing about a year ago, the global financial crisis had quite recently had its major impact on sweden. the problems mainly originated abroad – through the now cross - border financial markets and through the downswing in the world economy hitting an export - dependent economy like ours particularly hard. in the very turbulent and uncertain situation prevailing at that time, the main focus was on quickly making a diagnosis and implementing more or less acute measures – “ intensive care ” if you like. it was necessary to take rapid and forceful action to safeguard financial stability and to minimise the negative effects of the crisis on economic developments in general. for the riksbank and many other central banks the " normal ” tools have not been sufficient to achieve this. but we have adapted quickly, taken out a whole range of complementary tools from our workboxes, and even constructed some new ones! now, one year later, the most acute phase of the financial crisis is now hopefully behind us. although we have not yet climbed out of the trough that turned out to be the worst economic downturn since the war. but there are many indications that we have passed the turning point. in my speech today i intend to provide a brief status report of where we stand today and how we should to proceed. are we about to land on our feet? how does the economic situation look today from a monetary policy perspective and what lies ahead of us? what is the