hermann remsperger : stabilising the economy and the financial system – lessons and challenges for monetary policy and supervision keynote speech by professor dr hermann remsperger, member of the executive board of the deutsche bundesbank, at the 16th central banking seminar of the bank of korea on " global stagflation threat and monetary policy ", seoul, 21 october 2008. * i * * introduction governor lee, members of the governing board of the bank of korea, ladies and gentleman, it is a great honour for me to be invited to deliver the keynote speech at the 16th central banking seminar of the bank of korea on " global stagflation threat and monetary policy ”. given the ongoing turmoil in the global financial system and the related risks for the world economy, the topic of this seminar is well chosen and timely. three closely interlinked developments are currently shaping events. the public focus is, of course, first and foremost on the financial crisis. starting from the united states in august 2007, the global financial system has been repeatedly shaken by new waves of heavy turbulence. these were driven by rapid and dramatic changes in market sentiment. investors and lenders have moved from trusting anybody to trusting nobody. a situation in which liquidity was simply assumed to be given has turned into a situation in which funding markets are frozen and dysfunctional. emergency measures have been taken by central banks and governments in many countries. these measures were often unprecedented in scale and unconventional in nature. with the financial storm intensifying in recent weeks, an increasing number of financial institutions in advanced economies have been encountering severe difficulties. what started as a liquidity crisis is turning out to be more and more of a solvency crisis. it represents a growing danger to the supply of credit and the proper functioning of the economies in advanced economies. moreover, the effects of the crisis are being increasingly felt in emerging markets, too. many of these economies are faced with capital outflows and reduced export demand. hence, we are confronted with a truly global challenge. this brings me to my second observation. surging commodity prices, until very recently, and the current financial market turmoil have resulted in a marked slowdown of global economic activity. with the financial crisis deepening, uncertainty about the outlook for the global economy is increasing, while growth risks are biased strongly to the downside. following a roughly 5 % increase in each of the past few years, the imf now expects global economic growth to slow to close

conversely, the insights gained from regular contact with the banking industry in the practical conduct of refinancing operations and in payments are helpful to the banking supervisors. finally, i think that the international governance of the financial systems has to be subjected to critical scrutiny. if we are thinking about changes, i believe we should strengthen those institutional structures that did their job well during the financial market turbulence. for me, this means that, first and foremost, the fsf should continue to play a key role. its membership drawn from central banks, ministries of finance, supervisors, regulators and international institutions means that the holistic assessment of the financial system is one of the main strengths of the fsf. the international monetary fund should mobilise all its resources in the fsf, above all, with an in - depth analysis of the way the financial system interacts with the real economy. for the analysis of these interactions, the imf can draw on decades of experience in article iv consultations and a decade of financial sector assessments. v conclusions ladies and gentlemen, what are the key lessons and challenges that we should take on board from our journey through economic history, from the stagflation episode of the 1970s and early 1980s to the financial crisis of today? one simple but fundamental lesson consists in knowing the strengths, as well as the limitations, of the various areas of policy. the primary mandate of the central banks is to safeguard price stability. at the same time, they often also have the task of contributing to financial stability. price stability and financial stability are, in turn, necessary conditions for sustained growth and prosperity. regarding the primary mandate of central banks, three important lessons can be drawn from the past decades. first, anchoring inflation expectations at a low level is and remains of crucial significance. here, credibility is the key to success. second, monetary policy has to be symmetric. it is important to identify emerging financial imbalances at an early stage and, if necessary, respond accordingly. a broad - based monetary analysis turns out to be an important analytical device. third, in a world of growing real and financial integration, a sufficient degree of exchange rate flexibility can help ensure price stability when macroeconomic conditions differ at home and abroad. while many advanced economies have learned that lesson – sometimes the hard way – it still poses a challenge for some emerging market economies. this brings me, finally, to the challenges. it has become very clear to me that a lasting stabilisation of the financial system