met by households and firms minus expected inflation, that is too high. the market rate exceeds the repo rate with a spread that is determined by see svensson, lars e. o. ( 2003 ), " escaping from a liquidity trap and deflation : the foolproof way and others, " journal of economic perspectives 17 ( 4 ), 145 - 166, for literature references and a review of this research. my own contribution to this research can be found on my website, www. princeton. edu / svensson. various risk and liquidity premia. this spread is now unusually large due to the financial crisis. this means that the market rates are positive even if the repo rate is zero. with some simplification, the real market rate can be specified as : real market rate = nominal market rate – expected inflation = repo rate + spread – expected inflation. even if the repo rate is reduced to zero, the real market rate can be too high, because the spread is large and / or because the expected inflation is low. 4 the real market interest rate can thus be lowered, if the spread can be reduced. the measures implemented by the central banks and other authorities in various countries to improve the functioning of the financial markets, what ben bernanke calls " credit easing ", 5 can reduce the spread and thus contribute to a lower market rate. however, even if the various spreads are still larger than normal, it is, quantitatively probably only a rather moderate reduction of the real market rate that is possible in this way. the really substantial effect on the real market rate can instead be achieved if inflation expectations can be raised. it is particularly dangerous if, instead, expectations of deflation arise, that is expectations of negative inflation. the real interest rate may then become far too high. a nightmare for central banks is a downward spiral, in which a too high real interest rate slows down the economy and leads to increasing deflation and expectations of decreasing inflation, which in turn lead to a still higher real interest rate that slows down the real economy even more and leads to even greater deflation. with a zero lower bound it is therefore important for the central banks to affect and raise inflation expectations in some way. how this should be done is the real problem with a zero lower bound for the interest rate bound and a liquidity trap. it may even be necessary to raise inflation expectations above the inflation target for a while in order to achieve a sufficiently

your banking system. where there are shortcomings you must deal with these in the appropriate ways, such as through legislation. while waiting for the preconditions to improve, the authorities and the banks must compensate for the shortcomings. let me stress this again : your banks, as well as other financial institutions, cannot operate efficiently and soundly in an environment where the necessary preconditions are inadequate. regulation banks perform special and unique services to society, such as accepting deposits and transforming them to credits, and for providing payment services. the combination of receiving short - term deposits and extending long - term loans makes banks inherently unstable. for this they may receive some protection by the public, such as the possibility of liquidity support and depositor guarantees. but the price for receiving protection is that banks must be subject to some regulation and supervision. having acknowledged this, i am not a fan of extended bank regulation but rather regulation of a limited and transparent type, intended to protect society against major incidents and costs but allowing banks to conduct and develop their business as flexibly as possible. clearly, bank regulation must aim at promoting efficiency and stability. only efficient banks will remain stable in the long run. the old - fashioned type of regulation forcing banks to do business on other than market - oriented terms must be abolished. if the government wants to subsidize certain activities, such as banking for people in remote geographical locations, mortgage lending on favourable terms, or lending to important borrowers or projects, the costs for this should be transparent and show up as a part of the fiscal budget. such activities should not be conducted by directives from the government to the banks. another type of regulation which is becoming increasingly obsolete and inefficient is when the authorities try to micro - manage the behaviour of the banks by setting upper or lower limits on fees, deposit rates, lending rates, and credit expansion. the situation in the economy changes so rapidly that the authorities will never be able to catch up and their actions could then be more harmful than helpful. the type of regulation i would like to promote is flexible. the regulation will not obstruct developments in banking while at the same time it prevents banks from behaving in a way that might harm customers or themselves, other institutions or markets, or society as a whole. without going into detail i could mention the new basel ii framework for capital requirements on banks as an example of such flexible regulation. under basel ii, banks may assume