do not lay the ground for similar disorder in the future. we can only do so – and this is my main proposition today – if we design policies in such a way that we do not go back to the status quo ante and instead firmly enshrine in our policies the appropriate focus on ensuring stability over the medium term. i would like to explain what i mean by this. the global economy was – and, to a significant extent, still is – imbalanced. it is imbalanced in three domains : in its financial system, in its macroeconomic configurations, and in the governance of the financial architecture. the present crisis does not just offer us an opportunity to rebalance, it provides an obligation to rebalance these three intertwined domains of the global economy. these are the key challenges we must not fail to address, no matter how difficult the related work agenda. the root causes of the crisis let me outline where i see these challenges more specifically, starting from the root cause of the crisis. clearly, the root cause of the crisis was a massive underestimation of risk in the financial sectors of virtually all advanced economies. risks were blurred owing to financial innovation that had produced highly intransparent financial products. these allowed for a generalised deterioration in lending standards. the drop in virtually all credit spreads and the asset price booms were particularly important in spurring households and firms to increase consumption or accumulate debt at a rapid pace. much of this boom was based on the erroneous assumptions that house prices and asset prices would continue to increase indefinitely, and that macroeconomic cycles had been eliminated. in 2007 market participants began to notice that these assumptions were unrealistic. asset and house prices fell, financial institutions were caught with excessive leverage, and households and firms quickly became overindebted. as a second factor, we need to recognise that economic policies also played an important role. macroeconomic policies in several economies were not sufficiently focused on mediumterm stability and sustainability, which would have helped prevent macroeconomic imbalances from accumulating. this was mainly due to the erroneous belief that in a globalised economy, it would be optimal for some countries to borrow from the rest of the world, or accumulate claims on other countries, indefinitely. this belief was initially encouraged by years of rapid global growth. but ultimately it proved mistaken. the financial crisis led investors to shun risk. they became less willing to allow households, firms and entire economies to accumulate

debt. as a third factor, we have observed clear imbalances in global governance. still at the current juncture we must be aware of the shortcomings in the international financial architecture. here, it is not necessarily the analysis that was the problem : the rising risks in the global financial system were identified in the process of international cooperation. the imf coordinated a multilateral consultation in 2006 - 07 to address global imbalances. the g7 and the g20 regularly flagged concerns related to imbalances in their communiques. policy recommendations were developed, but not appropriately enforced during this period. also, the dangers of a sharp and abrupt correction were not generally perceived as grave and quasi - immediate. i have to say that in this respect it is in the constituency of central banks that we can find the clearest public statements on the need for the private sector to prepare for a very serious market correction. this was the sentiment of the global economy meeting of central banks governors in basel as early as 2006 and the beginning of 2007. and the bank for international settlements itself in its own research had been the most lucid of the international institutions. the course of action to be undertaken looking ahead, what actions should be undertaken to redress imbalances in the global financial system, in macroeconomic policies and in international governance? for the financial system, there is a need for more stringent regulation. such regulation needs to prevent a recurrence of the excesses witnessed in financial markets and must impose a much more stability - oriented perspective. the financial stability forum has already identified the key avenues for reform. these include three policy areas where change is particularly warranted, in my view : • first, introducing incentives and rules to prevent the financial sector from focussing excessively on short - term returns ; • second, improving transparency as regards risks to the financial system, as well as regarding institutions, instruments and markets that are currently unregulated or insufficiently regulated ; and • third, eliminating, wherever possible, the elements that amplify the tendency of the financial system to accumulate excessive risks and leverage in good times, and to shed risks hastily in bad times – i. e. dampening pro - cyclical tendencies. i have dwelled upon these three issues on other occasions. these points are also reflected in the g7 communique issued last saturday, and i will not elaborate on them further. what i would like to emphasise today is the overall setting of macro