segments of the real estate market. in response, the federal government has instituted four prudent and timely tightenings of mortgage insurance terms. osfi has introduced tougher underwriting standards for home - equity loans and enhanced supervisory scrutiny. monetary policy has remained focused on the inflation target, although under flexible inflation targeting the bank of canada is prepared to support regulatory efforts, if necessary, and consistent with price stability over the medium term, to ensure balanced and sustainable growth. 4 r. dobbs et al., “ the world at work : jobs, pay, and skills for 3. 5 billion people, ” mckinsey global institute, june 2012. this share grew from 9 per cent in 1990 to 13 per cent in 2007 ( united states : 18 per cent ; united kingdom : 14 per cent ). see s. matthews ( 2011 ), “ trends in top incomes and their tax policy implications, ” oecd taxation working papers, no. 4, oecd publishing, 2011. bank of canada, “ renewal of the inflation - control target : background information – november 2011. ” bis central bankers ’ speeches even though desirable, eliminating the household sector ’ s net financial deficit will eventually leave a noticeable $ 50 billion gap in our economy over two years. this gap can only be sustainably filled by additional exports and business investment. but investment for what purpose and exports to where? the u. s. economy is experiencing the slowest recovery since the great depression as the repair of bank, household and government balance sheets slows growth. the only good news is that some progress is being made. u. s. banks have substantially increased their capital ( common equity to total assets is up by more than 25 per cent ). american households have recovered more than two - thirds of the $ 16 trillion fall in their net worth in the aftermath of the crisis, though we estimate that it will take several more years for households to make up the balance. despite this, total debt in america has barely fallen from its peak of 250 per cent of gdp – a level last seen in the great depression. 5 this is because u. s. government debt has increased $ 4 for every $ 1 reduction of household debt. such treading water will persist for some time since private domestic demand is still not sufficiently robust to outweigh an aggressive fiscal tightening. the bank expects the u. s. expansion to average 2. 5 per cent over the next few years ( compared to 3 per cent in the

but in many of the advanced economies, notably the united states and europe, economic growth has been sluggish, as households, firms and financial institutions continue to repair the damage to their balance sheets. as i will discuss later, this two - speed recovery creates a new configuration of risk in the global financial system. here in canada, the financial system proved more robust than in other advanced economies, although problems with asset - backed commercial paper could have had very serious ramifications had it not been for timely official intervention. the bank of canada had to inject substantial amounts of liquidity into the system to keep core funding markets functioning. nonetheless, canada suffered a severe recession, mainly because of the collapse in our exports. the recovery is now well under way, both in canada and globally. indeed, in canada, we are already in an expansion, as we have surpassed pre - crisis levels of economic activity and employment. but we must still ask how the crisis happened, and what must be done to avoid a recurrence. what happened in the crisis? perhaps the biggest surprise of the crisis was the fact that defaults of subprime mortgages in the united states – a small segment of that country ’ s housing market – could cause the global financial system to unravel. as events unfolded in the autumn of 2008, we were reminded that the global financial system is bound together by an extensive web of interconnections. these interconnections among financial institutions and markets can spread trouble to unexpected places and cause small shocks to have outsized effects. the financial crisis highlighted three main weaknesses in the way that the system handled risk. first, many financial institutions were excessively leveraged, had inadequate cushions of capital to absorb losses and insufficient liquidity to function in stressed market conditions. bis central bankers ’ speeches second, the complex and opaque web of securitized lending and derivatives markets, which were believed to help the economy better manage and distribute risk, instead turned out to transmit and amplify that risk. third, financial institutions that were “ too big to fail ” had diminished incentives to manage risk and, ultimately, shifted those risks to taxpayers. these vulnerabilities were permitted to build up – or were even fostered – by the perception of diminishing risks in the great moderation. financing patterns that appeared wellconstructed in the context of ever - diminishing risk turned out to be imprudent once the system came under stress. regulation fell