financial markets stemming from the u. s. subprime mortgage problem, and the slowdown in the global economy. ii. the surge in energy and materials prices and japan's economy first, i will address a topic related to the surge in energy and materials prices. a rise in such prices exerts downward pressure on japan's economy, which depends heavily on imports of resources, through a decrease in purchasing power – an outflow of income. at the same time, it exerts upward pressure on prices. let us look back on the two oil crises japan previously faced. during the first oil crisis, crude oil prices surged from 3 u. s. dollars to 12 dollars per barrel – a fourfold rise – in a brief period between 1973 and 1974. during the second oil crisis, they surged from 15 dollars to 40 dollars between 1979 and 1980. unlike these two cases, the current surge has been continuing over an extended period, which makes a comparison of the rise in oil prices difficult, since the extent of the increase differs depending on where one starts the calculation. if we start from 2002, when the level of oil prices was 21 dollars, the current level of 110 - 120 dollars – somewhat below the recent peak – is more than five times the level recorded in 2002. this means that the rise during the current phase has been the largest, even compared with the two oil crises. as a result, the size of the income outflow resulting from the surge in oil prices has also been the largest during the current phase : about 5 percent of real gdp, compared with about 3 percent during the two oil crises. rises in crude oil prices, as well as the resultant outflows of income and decreases in production capacity, should be accepted as given conditions for japan's economy. in other words, they cannot be avoided. however, economic and price developments differed markedly between the periods immediately after the two oil crises emerged. during the first oil crisis, japan's economy suffered from a combination of runaway inflation and economic stagnation – in other words, stagflation. economic indicators show that the economy, which continued enjoying rapid annual growth of 8 - 9 percent until 1973, suddenly contracted by 1 percent in 1974 and cpi inflation peaked at an annual rate of 25 percent in 1974. contrarily, during the second oil crisis, the economy continued to grow at a rate of 3 - 5 percent and the cpi posted only a single - digit increase. at that time

their lending attitudes. this has exerted strong downward pressure on the economy. most recently, a third stage has emerged. in this stage, delinquency rates of not only subprime - related products but also commercial real estate loans and consumer loans have been rising reflecting the sluggishness in the u. s. economy. as a result, a situation in which the sluggishness in the economy causes financial institutions'asset quality to deteriorate further – with further adverse impact on the economy – is becoming a cause for concern. to put it another way, at the third stage there are concerns about a negative feedback loop between financial markets, asset prices, and economic activity. many discussions have taken place on what kinds of lessons can be drawn from the u. s. subprime mortgage problem. since the nature and background of the problem are complex, i hesitate to draw lessons prematurely. it might be argued that the cause of the problem was investors'and financial institutions'lax risk management. this observation seems to me accurate, but it would not be true to say there were no warning signs about the accumulation of risks. we must therefore pursue the reason why many market participants made the mistakes that eventually led to the problem despite the warning signs. although solutions at this point have yet to fully emerge, several major issues – although not completely new – seem again to have come to the fore. looking back at previous bubbles in financial activities and asset prices, including japan's asset price bubble, we can see that many have occurred following a period of price stability and continued low interest rates. in the current phase too, investors and financial institutions eased their credit standards and increased dependence on loans or leverage, accelerating their " search for yield " through investment in, for example, securitized products. underlying this situation were excessively accommodative financial conditions and credit expansion on a global scale – amid a prolonged period of economic growth and low inflation. on the other hand, when bubbles burst, capital bases of financial institutions are impaired and the period of credit contraction begins, depressing economic activity and constraining the transmission of monetary policy. similar to cases when bubbles emerge, the current u. s. subprime mortgage problem keenly illustrates that it is difficult to recognize the bursting of a bubble as it happens. central banks should therefore pay due attention, in their conduct of monetary policy, to the negative effects that may arise from prolonged accommodative financial conditions