focus on the implications of the crisis for what i have been calling economic science, that is, basic economic research and analysis. i will first provide a few examples of how economic principles and economic research, rather than having misled us, have significantly enhanced our understanding of the crisis and are informing the regulatory response. however, the crisis did reveal some gaps in economists ’ knowledge that should be remedied. i will discuss some of these gaps and suggest possible directions for future research that could ultimately help us achieve greater financial and macroeconomic stability. how economics helped us understand and respond to the crisis the financial crisis represented an enormously complex set of interactions – indeed, a discussion of the triggers that touched off the crisis and the vulnerabilities in the financial system and in financial regulation that allowed the crisis to have such devastating effects could more than fill my time this afternoon. 1 the complexity of our financial system, and the resulting difficulty of predicting how developments in one financial market or institution may affect the system as a whole, presented formidable challenges. but, at least in retrospect, economic principles and research were quite useful for understanding key aspects of the crisis and for designing appropriate policy responses. for example, the excessive dependence of some financial firms on unstable short - term funding led to runs on key institutions, with highly adverse implications for the functioning of the system as a whole. the fact that dependence on unstable short - term funding could lead to runs is hardly news to economists ; it has been a central issue in monetary economics since henry thornton and walter bagehot wrote about the question in the 19th century. 2 indeed, the recent crisis bore a striking resemblance to the bank runs that figured so prominently in thornton ’ s and bagehot ’ s eras ; but in this case, the run occurred outside the traditional banking system, in the shadow banking system – consisting of financial institutions other than regulated depository institutions, such as securitization vehicles, money market funds, and investment banks. prior to the crisis, these institutions had become increasingly dependent on various forms of short - term wholesale funding, as had some globally active commercial banks. examples of such funding include commercial paper, repurchase agreements ( repos ), and securities lending. in the years immediately before the crisis, some of these forms of funding grew especially rapidly ; for example, repo liabilities of u. s. brokerdealers increased by a factor of 2 – 1 / 2 in the four years before the crisis,

union, and which have led to an improvement in our standard of living that the current difficulties should not let us forget. yet that should not mask the fact that belonging to a monetary union entails a series of constraints or commitments which, among other things, involve the necessary adaptation of economic agents ’ behaviour and of the means of pursuing economic policy. in a monetary union, the control of two essential instruments usually at hand to combat crises passes to a supranational level and, therefore, they cease to be available to meet the specific needs of the member countries : both very short - term interest rates – the key tool used by a central bank when setting its monetary policy – and the exchange rate have been set in the european monetary union, since 1 january 1999, on the basis of the aggregate bis central bankers ’ speeches situation of the area as a whole. they cannot be managed to serve the specific needs of any national economy. it is the national economies that have to be in a position to live with the standards set for the whole. national authorities retain control of the other economic policies, which remain under their responsibility ; however, the proper functioning of the area evidently requires that their handling should observe specific common principles, preventing misalignments in one country from prompting imbalances in the rest, or from destabilising the monetary union as a whole. the way in which these common principles have been implemented has differed depending on the specific economic policy tool in question. thus, for instance, fiscal policy coordination mechanisms have been the focus of particular attention, with monitoring and surveillance procedures to avoid excessive budget deficits ( of over 3 % of gdp ) and high public debt proportions ( over 60 % of gdp ) coming into play. indeed, these thresholds, along with the procedures for their prevention and ultimate correction, took the form in 1997 of an agreement known as the stability and growth pact. in contrast, the rules for coordinating “ structural ” policy ( e. g. those governing the workings of the labour market or the markets for goods and services ) were fairly lightweight as a result of their broader scope for application and of the difficulties involved in setting common objectives. also, in the area of financial regulation and supervision policies, countries continued to enjoy a high degree of independence. the limitations of the monetary union ’ s adjustment mechanisms as events have shown, the constraints imposed by the institutional framework were not powerful enough to ensure the appropriate response by national authorities in the face of potential slippage from the