target. if it is deemed to be a threat to the stability of the financial system, the brunt of the policy response would not be on monetary policy, but rather on the regulatory side. secondly, i think that the problem of how to manage the risks from asset prices in the monetary policy decision process to a large extent is pedagogical, i. e. explaining that we do not target asset prices, but that we do not completely ignore them. however, monetary policy is a topic on which a lot of people have an opinion, and you are never going to please everyone. in fact, in recent years the riksbank has been criticized for putting either too much, or too little, emphasis on property prices. finally, i would like underscore the necessity of stress - testing the banking sector for sudden shifts in property prices. you can have a whole staff of phds running all kinds advanced models telling you that assets are not overvalued. that ’ s fine, but at the end of the day they might be wrong, and then you would like to know what the consequences are going to be for the banking system. let me end by thanking the central bank of bosnia and herzegovina for hosting this conference and congratulate the bank on its 10th anniversary.

bill for the salvage operation in case the bank fails, the incentives to monitor the bank are huge. this dilemma is not new in theory, but has now become of great practical importance as financial globalization progressively is making national borders less relevant. asset prices, financial stability and monetary policy are there instances when these goals come into conflict with each other? this question has become particularly relevant in the last few years as asset prices have surged, while, at the same time, consumer price inflation has remained muted. on the whole, i think it is reasonable to assume that price stability in the long run reinforces financial stability. the main reason for this is that low and stable inflation reduces the risk of misallocating investments. although i believe that low inflation fosters financial stability, it would be wrong to disregard the possibility that changes in the inflationary process can have unintended consequences for the stability of the financial system. the success in bringing down inflation has lowered both nominal and real interest rates. moreover, factors such as the integration of emerging markets into the world trading system, and high productivity growth, has put downward pressure on prices of manufactured goods. this may have induced key interest rates to be lower, than what otherwise would have been justified in this cyclical position of the economy. given the fact that the low inflation regime has yielded high and stable growth, in conjunction with low interest rates, it is no wonder that asset prices have surged. while much of this price movement is fundamentally based, there is a risk that households and firms might become too optimistic about future earnings and interest rates. put differently, there is a risk that see e. g. schinasi, g. ( 2004 ) : ” defining financial stability ”, imf working paper, wp / 04 / 187. asset prices rise to unsustainable levels during the transition from a regime with high inflation to a regime with low inflation. another, but not unrelated issue, concerns how risk is priced in the credit markets. the last few years saw risk premiums in credit markets falling to record low levels. the fall in risk premiums meant that the effect on asset prices were more important than what the changes in the risk free rate alone would suggest. while low risk premiums, taken at face value, signal a healthy economy, many supervisors and central banks were concerned that risk premiums had fallen too far. as we all know, risk premiums in credit market rose dramatically this summer. uncertainty over the value of us sub