##ity and solvency position. the jury of course is still out on which model is the best as the crisis has discredited almost all models. i want to point out though that we need to reflect on the lessons of the crisis seriously before reforming our regulatory structures. fifth challenge : fiscal policy, financial stability and central bank independence the emerging regulatory architecture geared, among other things, to preserving financial stability will have implication for the prized independence of central banks. before 1970, it was typical across countries for monetary policy to be hostage to fiscal compulsions. but, following the stagflation of the 1970s and the ascendency of monetary policy thereafter, a neat arrangement started to emerge. governments started becoming fiscally responsible and monetary policy had started getting independent. this arrangement is now unravelling as a result of the crisis. unnerved by the scale and sweep of the crisis, governments and central banks around the world responded with an unprecedented show of policy force. central banks cut policy interest rates and have resorted to injecting massive liquidity in the system through a slew of measures variously called quantitative and credit easing. governments stepped in with fiscal stimulus packages raising fiscal deficits to levels not seen before in peace time. even as governments and central banks cooperated, the familiar tensions between fiscal and monetary policy have started playing up. it is widely hoped though that once the crisis is behind us, these tensions will melt away and monetary policy will once again be conducted independent of fiscal compulsions. on the other hand, there are apprehensions that this may not happen soon because of the expected protracted recovery and also because of structural factors that may keep fiscal deficits at elevated levels into the medium term. these tensions between fiscal and monetary policies could potentially militate against financial stability. if governments continue to incur large fiscal deficits, it will be that much more difficult for central banks to maintain price stability. while the current crisis has shown that price stability is not sufficient to ensure financial stability, price stability is decidedly a necessary condition for financial stability. higher inflation could also push the yield curve upwards. this could result in significant mark to market losses for fixed income instruments with potentially adverse implications for banks ’ profitability. this again could impair financial stability. in india too, we are confronting the dilemma of managing the tension between fiscal and monetary policies. the government has asked the finance commission to indicate a road map for returning to a path of fiscal consolidation. it is imperative that both the centre

. ( a ) unweighted average of the spread between euro - denominated senior unsecured bonds and equivalent maturity swap rates for bonds issued by the major uk lenders, which have a residual maturity of between two and six years. ( b ) unweighted average of the 5 - year cds premia for the major uk lenders : an indicator of the spread on long - term wholesale bonds. chart 6 : central bank balance sheets ( a ) indices : jan uary 2007 = 100 federal reserve eurosystem bank of england source : bloomberg. ( a ) in local currency. bis central bankers ’ speeches chart 7 : sterling corporate bond yields per cent per cent qe2 qe1 investment grade, non - financial ( left - hand scale ) high yield ( right - hand scale ) source : bank of america / merrill lynch. chart 8 : international equity prices ( a ) indices : 4 january 2007 = 100 qe1 qe2 euro stoxx s & p 500 ftse all - share ( a ) in local currency terms. bis central bankers ’ speeches chart 9 : constraints on investment spending ( a ) percentages of respondents recessions uncertainty about demand inability to raise external finance cost of finance internal finance shortage sources : cbi, cbi / pwc and ons. ( a ) manufacturing, financial services and consumer / business services surveys weighted by shares in real business investment. companies are asked for factors likely to limit capital expenditure authorisations over the next twelve months. financial service companies are not asked to distinguish between a shortage of internal finance and an inability to raise external finance, so their single response is used for both questions. bis central bankers ’ speeches references aiyar, s, calomiris, c and wieladek, t ( 2012 ) “ does macropru leak? evidence from a uk policy experiment ” bank of england working paper no. 445. bean, c ( 2003 ) “ asset prices, financial imbalances and monetary policy : are inflation targets enough? ” in a richards and t robinson ( eds. ) asset prices and monetary policy, 48 – 76. reserve bank of australia : sydney. bean, c ( 2010 ) “ the great moderation, the great panic and the great contraction ”, journal of the european economic association, april – may. bean, c, paustian, m, penalver, a and taylor, t ( 2011 ) “ monetary policy after the fall ”, in macroeconomic challenges