there was an extended period of price stability accompanied by stable growth and low unemployment. in the world that existed before the crisis, central bankers were a triumphant lot. they had discovered the holy grail. 13. the unravelling of the great moderation during the crisis has diluted, if not dissolved, the consensus around the minimalist formula of inflation targetting. the mainstream view before the crisis was that price stability and financial stability reinforce each other. the crisis has proved that wrong. we have seen that price stability does not necessarily ensure financial stability. indeed there is an even stronger assertion – that there is a trade - off between price stability and financial stability and that the more successful a central bank is with price stability, the more likely it is to imperil financial stability. 14. all in all, the crisis has given fresh impetus to the “ new environment hypothesis ” that pure inflation targetting is inadvisable and that the mandate of central banks should extend beyond just price stability. let me therefore turn to what the mandate should extend to. ( ii ) what is the role of central banks in preventing asset price bubbles? 15. a dominant issue in the wake of the crisis has been the role of central banks in preventing asset price bubbles. the monetary stance of studied indifference to asset price inflation stemmed from the famous greenspan orthodoxy which can be summarized as follows. first, asset price bubbles are hard to identify on a real time basis, and the fundamental factors that drive asset prices are not directly observable. a central bank should not therefore second guess the market. second, monetary policy is too blunt an instrument to counteract asset price booms. and third, central banks can “ clean up the mess ” after the bubble bursts. the surmise therefore was that the cost - benefit calculus of a more activist monetary stance of “ leaning against the wind ” was clearly negative. in other words, it is not the job of central bankers to remove the punch bowl no matter that the party is getting wild. 16. the crisis has dented the credibility of the greenspan orthodoxy. the emerging view post - crisis is that preventing an asset price build up should be within the remit of a central bank. opinion is divided, however, on whether central banks should prevent asset bubbles through monetary policy action or through regulatory action. on one side, there is a purist view that the case for monetary tightening to check speculative bubbles is questionable. opposed to this is the argument that a necessary

instruments have to be very clear that they are at risk of conversion or write - down. we cannot have a situation where holders gamble on an assumption that the trigger will not be pulled – it will. canada introduced the “ asset - to - capital ” multiple in the early 1980s. the definition pre - crisis was defined as on and some off - balance sheet exposures as a ratio of total capital. generally, this was set at the assets being no more than 20 times the total capital amount. however supervisory discretion could permit a higher multiple ( up to 23 times ) if the firm met certain conditions. in the us a minimum everage ratio was introduced in the early 1980s. pre - crisis, the definition used was tier 1 capital / on - balance sheet assets, as measured under us gaap. firms had to meet a 3 % ratio if considered “ strong ”, and 4 % otherwise. bis central bankers ’ speeches on the form and use of capital instruments, the basel i accord also allowed hybrid debt capital instruments to support the required deductions from the capital calculation, such as goodwill, expected losses ( introduced later under basel ii with the internal models regime for credit risk ) and investments in other banks ’ capital instruments. however, as a matter of fact, rather than reporting, any losses arising from these items hit common equity because it will absorb losses first in the going concern state, according to the hierarchy of the capital structure. as a result applying these deductions at the level of total capital, or tier 1 capital, has the effect of overstating the core equity capital ratio. the accord therefore incentivised wrongly the issuance of hybrid debt capital instruments to cover deductions. a further flaw was that deferred tax assets were not deducted from capital and minority interest assets were recognised in full. this, too, was a mistake. dtas depend on future profitability ( which is not assured ) and minority interests are not fully transferable to absorb losses for a group. last on the capital side, there were problems starting in the original basel accord in relation to the treatment of provisions. under the current international accounting standards provisions are based on incurred rather than expected losses. as a consequence, the bank capital framework de facto becomes a partial substitute means of achieving more forwardlooking provisioning, through the internal models regime for credit risk which requires the deduction from capital of expected losses in excess of provisions. a forward - looking approach to provisioning based on