gertrude tumpel - gugerell : monetary policy challenges in light of the current financial market developments speech by ms gertrude tumpel - gugerell, member of the executive board of the european central bank, at alpbach talks, vienna, 15 june 2009. * * * introduction ten years ago, on 1 january 1999, the euro was introduced as the common currency of 11 member states of the european union. today, the euro is used by around 330 million citizens in 16 countries and it has established itself as a stable currency, accepted in financial markets worldwide. looking at the inflation performance over the first decade of monetary union with inflation averaging slightly more than 2 % during this period, the ecb has fulfilled its mandate under the maastricht treaty, which is to maintain price stability for the euro area as a whole. nonetheless, undoubtfully, we are currently facing the biggest challenge so far : the world is hit by a severe economic and financial downturn, the deepest since the beginning of the great depression in 1929. it poses grave challenges to the financial industry and central bank community, as well as to supervisory and regulatory authorities and national governments and to the citizens at large. the key challenges arising from the current financial market turbulence since august 2007 the global financial markets have experienced extensive corrective realignments. the repercussions of the turbulence were initially visible in the financial market in the form of dramatic increases in risk premia and increased volatility in interest rate movements. the outbreak of the financial market turbulence was not entirely unexpected, however. both the ecb and other institutions had warned of macroeconomic imbalances and systematic undervaluation of risks in the years leading up to the crisis. those years were characterised by an extended period of low interest rates, low inflation and sustained economic growth, both globally and within the euro area. at the same time, liquidity was abundant and default risks were considered by many to be very low. this environment strengthened investors ’ risk appetite. in particular, with financial market participants expecting this environment to continue for quite some time, risks were systematically underestimated and the search for ever higher yields intensified. as a result, commercial banks readily granted credit for house purchases to households that otherwise could not have afforded it, and without adequately assessing their creditworthiness or credit default risk. at the same time, in an attempt to achieve higher yields, a number of innovative and increasingly complex financial products were offered, particularly in the

importance of the capital monitoring exercises, conducted by various international fora, including the basel committee, should be highlighted. these exercises are seeking to analyse the developments of the minimum capital requirements under the basel ii framework with the aim of assessing the level and cyclicality of capital requirements. this is the basis for exploring their possible impacts on banks ’ behaviour and the business cycle. since the complete elimination of cyclical variations in banks ’ lending activity would be an unrealistic goal, regulators should instead focus on reducing the occurrence and severity of systemic crises. to this end, the regulatory framework should be revised so as to restrain the build - up of excessive risks during the expansion phase and to dampen the costs of financial distress in the contraction phase. a major challenge for authorities, however, is the proper definition of a regulatory framework that would allow banks ’ capital buffers to shrink in downturns ( i. e. to absorb losses ), without creating moral hazard and regulatory arbitrage. i thank you for your attention.