and gain the credibility of market participants for a consolidation plan. however, the side effects of such operations become significant when the government ’ s commitment to fiscal reforms is weak and the plan for fiscal consolidation is less effective. specifically, a temporary lull in financial markets due to a decline in government bond yields is likely to dilute the sense of urgency among the government and the public, and thus weaken the momentum for progress toward fiscal reforms. if the government continues to run fiscal deficits, a possibility arises in which the central bank is forced to supply an unlimited amount of liquidity – in the form of either liquidity provision against government bonds as collateral or an outright purchase of government bonds – in order to get around a re - emergence of financial system instability. historically, the consequence of such a large - scale supply of money is uncontrollable inflation. if market participants and the public, which have the knowledge of this history, were to anticipate a regime shift at some point, the credibility with respect to government bonds and money would be lost abruptly, and a process leading to uncontrollable inflation would begin. after all, without solid progress toward fiscal consolidation, we cannot avoid significantly adverse impacts on economic activity and the standard of living. bis central bankers ’ speeches the case of japan now i would like to take up the case of japan, which attracts frequent questions. as is well known, the ratio of gross government debt to gdp in japan is the highest among developed countries. in spite of such unfavorable fiscal conditions, the government bond yields remain low and stable, and policy discussions are focused on mild deflation instead of concerns regarding inflation, as evidenced by the fact that the consumer price index has fallen by 3. 4 percent in cumulative terms since 1998, which can be translated to 0. 2 percent annually. the low level of the government bond yields is consistent with the growth rate of the economy and the inflation rate, and at issue is the interpretation of the premium that could arise from worsening fiscal situations. it seems difficult to explain the case of japan in light of the conventional wisdom. one frequently offered explanation is that the ample domestic savings in japan have absorbed the issuances of japanese government bonds ( jgbs ) and the share of jgbs held by foreign investors is very small. but a more fundamental explanation is that the stability in the government bond yields reflects market participants ’ expectations that fiscal soundness will be restored through structural reforms in both the economic

this framework, or the focus on the stability of general prices underlying it, now faces new challenges. from the viewpoint of price stability, economic performance was benign for a prolonged period through the mid - 2000s, giving no apparent cause for concern, but a large - scale credit bubble built up, culminating in the global financial crisis. as a result, numerous advanced economies are currently experiencing severe bis central bankers ’ speeches balance - sheet adjustments associated with the bursting of the bubble. these developments are having a subtle impact on how inflation targeting and, for that matter, monetary policies are managed. having said that, i am by no means arguing that there is no point in money supply targeting or inflation targeting. in my view, history seems to suggest that – be it with regard to the lender of last resort function or monetary policy – it is necessary to constantly review measures of monetary control in light of changes in the environment. in other words, constant innovation is necessary. iii. central banks ’ policy responses following the global financial crisis next, from this perspective of constant review and innovation, i would like to move on to various unconventional policy measures that major central banks took in the course of the recent severe financial crisis. while the term “ unconventional policies ” can be understood by different people in a number of ways, in what follows i will talk about unconventional policies by dividing them into two categories : first, measures taken in the midst of the recent financial crisis as part of central banks ’ lender of last resort function and aimed at ensuring the stability of the financial system, and second, measures taken in less difficult times, after the crisis had settled, that aim at stabilizing economic activity. 4 as for the former, the measures were, in essence, in line with the lender of last resort principle emphasized by bagehot. however, naturally, the financial system in the 21st century is not quite the same as that in the 19th century when bagehot lived. central banks around the world have faced new challenges he never imagined, and have worked with considerable ingenuity. resolving the issue of stigma in the course of the recent financial crisis, the first challenge was to resolve the stigma attached to receiving emergency funds from the central bank. while aggressive liquidity provision is critical in a crisis, financial institutions might hesitate to borrow funds even in an emergency and try to raise funds in the market at all costs out of fear that their perceived creditworthiness will decline if it becomes known that they received emergency funds.