the real estate in japan, the capacity of monetary policy to stimulate demand and inflation is bound to be severely impaired. even if such strategy had proved to be successful, it would only have delayed the inevitable adjustment between the asset prices and economic fundamentals. 13. if central bank's predicting ability of post - bubble developments has to remain less than perfect, would it better once again to consider aggressive tightening when a bubble is perceived to be growing? this is the question i talked about three years ago here. i remain skeptical as i was. however given the fact it is always the preceding massive flows of credit that become worthless once the tide is reversed, leaving severe damages on the balance sheets of parties concerned, it might be worth considering possible ways to focus on restraining “ excessive ” credit flows during asset market upswings ( see chart 6 for the development of credit and asset prices in japan ). chart 6. credits and asset prices in japan notes : real aggregate asset price indices are a weighted average of equity and residential and commercial estate price indices deflated by consumer prices. the weights are based on the composition of private sector wealth. sources : bank for international settlements, quarterly review, international banking and financial market developments, august 1999 14. let me conclude by adding a few observations in somewhat broader context. it is ironic that, as the track record shows ( chart 1, chart 2 ), the bank of japan followed a path in the 1980s and early 1990s that could be regarded as fully consistent with some policy rule such as taylor rule, and yet suffered from the wildest swings of asset markets. suggestions have been made that the bank should have deviated from such implicit rule - based path both in times of upswing as well as downswing. from my perspective, for discussions on policy rules to be more relevant and robust, they should at least take into account major swings of asset prices. our experience shows that price stability, by making low interest rate possible, can pave a way to a major asset price bubble when it is coupled with excessive optimism for the future. 15. finally, what matters most in the post - bubble development is the magnitude of the lost capital and its distribution ie who in the system has to absorb the loss. in japan, that magnitude has been overwhelming and has concentrated in the banking sector. when an economy is faced with the size of lost capital as japan was, well - functioning financial infrastructure is crucially important for its prompt resolution. infrastructure in this context includes proper accounting

inflation rate required to offset the negative shock generated by collapsing asset bubbles should well exceed the target if the country in question were pursuing an inflation targeting. the central bank pursuing such a strategy would have to be fully convinced, substantiated by quantitative analyses, and strongly concerned about the risk of deflation a few years into the future. without such a superb insight, it would be hardly possible for a central bank to abandon a price target, explicit or implicit, at a stage when deflation is yet a remote potential risk. 9. economic predictions are inevitably clouded by uncertainties. what makes economic reading in the post - bubble period uniquely difficult is the great uncertainties associated with the asset market developments. first, we cannot be sure how the asset markets will develop and where an equilibrium with the real economy will be restored. in addition, different asset segments can show divergent price patterns, as was the case in japan's stock and real estate markets in 1990. such divergence can emerge at an early stage when bubble - day inertia of wishful thinking lingers with the confusing effects on expectations. thus the possible size of capital loss and its harm on the financial health of businesses and households is extremely difficult to estimate. 10. second, uncertainty also exists in the transmission mechanism between asset prices and real activity and inflation. in an economy like japan where banks dominate financial intermediation ( chart 3 ), capital losses tend to gradually accumulate in the banking system. indeed there was a presumption that shocks would be contained within the financial sector and would not spread to the real side of the economy. therefore, there was a widespread belief that the situation would turn around if business could be sustained until land prices started to rise again. when bank capital was eroded to a critical threshold, however, an acute credit crunch erupted. it is against such uncertain setting that economic forecasting must incorporate the timing and magnitude of the “ headwind ” generated by the deteriorating balance - sheet conditions of businesses, households and particularly banks. chart 3. financial structures [ 1 ] financial liabilities held by non - financial corporations ( ratio to total financial liabilities ) [ 2 ] financial assets held by households ( ratio to total financial assets ) notes : 1. figures are those for the end of 1999. 2. regarding financial debt for enterprises, stocks are evaluated at the market value, and, thus, do not necessarily correspond to the accumulated funding by enterprises. it should be noted that u. s. for equi