to loss provisioning. also, many banks had adopted capital models that tended to reduce the capital backing of loans when markets were strong and increase capital backing when markets were weak. in this sense, the existing prudential framework failed to take account of the growing systemic risk arising from the sustained boom in credit and asset prices that occurred between 2002 and 2007. the lesson was clear : prudential policy should take more account of macro - financial risks as well as the micro - financial risks specific to individual banks. in response to this lesson, macro - prudential policy has become an active new area of policy development internationally. in the basel iii regime, the important new macro - prudential element is the counter - cyclical capital buffer ( ccb ) : an additional capital requirement that local supervisors may apply when credit is booming, and remove when the cycle is turning down ( figure 3 ). a range of other instruments are also being developed and applied in various countries under the general heading of “ macro - prudential ” policies. in broad terms macro - prudential policies are aimed at reducing financial system risk by introducing additional safeguards, such as capital and liquidity buffers or collateral requirements that vary with the macro - credit cycle. such policies will also tend to have the effect of either : 1 ) dampening the credit cycle ; or 2 ) dampening international capital flows and hence exchange rate pressures. for those reasons, macro - prudential policies might be expected to play a useful secondary role in helping to stabilise the macro - economy. bis central bankers ’ speeches figure 3 countercyclical capital buffer ( credit - to - gdp ratio, deviation from trend ) source : rbnz at the reserve bank we have been doing a lot of thinking about potential macro - prudential policy instruments and how they might be used1. the four instruments we currently consider viable candidates are : the counter cyclical capital buffer the core funding ratio adjustments to sectoral risk weights2 limits on loan to value ratios ( lvr ’ s ) the reserve bank already has powers under the reserve bank act to modify prudential instruments with the objective of financial system stability and efficiency. however, this is a new approach to prudential policy and as such we are developing, along with treasury, an explicit macro - prudential governance framework to be agreed with the minister of finance as a basis for policy decisions going forward. we expect that the reserve bank will take the lead role in implementing

alarming and it should be borne in mind that in recent years underlying domestic inflation has been exceptionally low. the downward price effects from deregulations, for example, have been greater than we expected initially — and presumably than we can count on in the future. so how will domestic inflationary pressure develop in the future? will it continue to creep up? wage agreements that have been concluded to date are admittedly in line with what we allowed for but in an international perspective they are on the high side. there are also risks of higher wage outcomes in some of the areas where settlements are still pending and, in that case, of this spreading throughout the labour market in the coming years. that could add to domestic price pressure. this might be particularly troublesome if it were to be accompanied by falling productivity, which has been the historical pattern in an economic slowdown. there are grounds, however, for being cautious about historical comparisons. some slackening of productivity seems likely but not to the same extent as previously because firms now seem to adjust their labour force more quickly. these, briefly, are the tensions in the situation in which monetary policy is being formulated at present. on the one hand a clear slackening of international activity that may become more marked ; on the other, wage negotiations that can still cause problems, rising domestic inflationary pressure and an exchange rate that may lead to inflationary impulses. it is still too early to judge the strength of these factors and reach conclusions about which of them will predominate. against this background it is important during the spring to maintain a high state of readiness for a repo rate adjustment if new information indicates that this is called for.