including real estate, which is the sector associated with most of the severe financial crises in history. the mirror image of this development was a credit bubble in the banking sector, as banks financed both housing supply, i. e. loans to real estate developers, and housing demand – that is, mortgages. when the crisis broke out, this debt build - up quickly became a debt overhang. many advanced economies entered a prolonged period of deleveraging as firms, households and banks attempted to reduce their debt levels. for firms, this meant less investment. for households, less consumption. and for banks, less credit. moreover, the collapse of lehman brothers sent shockwaves through the global financial system leading to an unprecedented rise in uncertainty and risk aversion. this led to a further retrenchment in investment, trade and hiring and a globalised “ great recession ”. government budgets went deep into deficit to offset this massive shock to nominal spending. these events were not only shared across major economies, but they were also largely consistent with historical experience. there have been several episodes in economic history bis central bankers ’ speeches of large build - ups followed by periods of debt deleveraging. serious financial crises tend to be followed by slow economic recoveries. nevertheless, by mid - 2010, most advanced economies were showing signs of returning to growth, albeit at a slow pace. at this point, however, the trajectory of the euro area departed from others. while the recovery gained ground in the us in particular, the euro area entered into a second recession that lasted until the second quarter of 2013. why did this divergence happen? for two reasons that were specific to the euro area. first, the sequencing of policy responses after the first bail - out for greece aggravated concerns about bank and sovereign debt sustainability. second, these concerns interacted with an incomplete institutional framework in a self - reinforcing way. in addressing the situation in mid - 2010 – and with the benefit of hindsight – one could have legitimately expected the following sequence of actions. first, agree on a solid backstop for dealing with sovereign and banking sector problems. thereafter, conduct a stress test and recapitalise banks where necessary. then, with banks in a stronger position to absorb losses and a sovereign backstop in place, construct a consistent framework for dealing with sovereigns with excessive debt. finally, apply that framework to countries that were deemed to need it. for example, this sequence from backstop to stress test

will seek to be transparent about the assumptions and results. asset prices, credit and monetary policy there is a division of roles in economic policy. fiscal policy, through growth in public spending, influences the real krone exchange rate and the size of the international exposed business sector in the long term. monetary policy steers inflation in the medium and long term and can in addition contribute to smoothing fluctuations in output and employment. see european central bank, december ( 2008 ) : “ covered bonds in the eu financial system ”. basel committee on banking supervision ( 2009 ) : “ comprehensive response to the global banking crisis ”, press release of 7 september. financial services authority ( 2009 ) : “ strengthening liquidity standards ”, policy statement 09 / 16, uk october. house prices in norway have risen sharply and probably excessively. we must take account of developments in equity prices and property prices when projecting inflation and output. norges bank ’ s interest rate setting does not rely solely on one simple rule. instead, we seek to take account of all factors that influence inflation and output in the medium term, and the key policy rate is set on the basis of an overall assessment. asset prices such as house prices, the exchange rate and credit growth therefore have a bearing on norges bank ’ s interest rate setting. a written formulation of norges bank ’ s monetary policy reaction function would be fairly comprehensive and include all the variables that are considered. however, a reaction function must not be confused with the monetary policy target – our target function. the fact that we give weight to variables such as the exchange rate, house prices and credit growth in interest rate setting does not imply that there are specific target for these variables. the operational target for monetary policy is annual consumer price inflation of close to 2. 5 per cent over time. interest rate setting in a small, open economy can be particularly challenging in periods of strong credit growth and a wide interest rate differential against other countries. a tightening of monetary policy in norway specifically aimed at curbing property prices and credit growth can result in a rising krone exchange rate, a weaker labour market and excessively low inflation. should we seek to avert bubbles in the housing market even when medium - term inflation prospects are moderate? on this point, it is our judgement that a distinction must be made between giving greater weight to credit growth and house price inflation in the reaction function and defining house price inflation as an independent monetary policy objective. socalled “ leaning against the wind ” would not