øystein olsen : integrating financial stability and monetary policy analysis speech by mr øystein olsen, governor of norges bank ( central bank of norway ), at the systemic risk centre, london school of economics, london, 27 april 2015. * * * please note that the text below may differ slightly from the actual presentation. accompanying charts can be found at the end of the speech or on the norges bank ’ s website. thank you for the opportunity to talk to you here at the systemic risk centre this evening. the centre is bringing forward research and applied knowledge in a subject that has now become a key issue in central banking. in the aftermath of the 2008 – 09 financial crisis, central banks and academia have put systemic risk and the interlinkages between monetary and financial stability high on the agenda. the crisis showed that keeping inflation low and stable was not sufficient to prevent imbalances in the financial system. it also showed that, left alone, the financial system is prone to excessive risk - taking. and we were reminded of how costly a financial crisis can be. another lesson, more specific to central banks, is that there are synergies to be gained from closer integration of financial stability and monetary policy analysis. a clearer macroprudential dimension has now been incorporated into banking regulation. examples of this new orientation are the introduction of a systemic risk buffer and a timevarying countercyclical capital buffer for banks. the new macroprudential toolkit is being accompanied by higher permanent capital requirements and new regulations on banks ’ capital structure. the aim is to make the financial sector more resilient to shocks and to prevent or mitigate the build - up of systemic risk. as the new regulatory regime has been introduced, another dimension has been added to the discussion. the question being asked is the following : do reformed banking regulation and the new macroprudential instruments relieve monetary policy of any responsibility for financial stability? a good starting point for the discussion is tinbergen ’ s basic principles, which state that a wider set of policy instruments makes it possible to achieve a wider set of objectives and that each instrument should be assigned to the objective it can achieve most effectively. 1 the comparative advantage of monetary policy is to control inflation and smooth fluctuations in output and employment. the first line of defence against shocks in the financial system is, on the other hand, regulation and monitoring of financial institutions. macroprudential policy is part of this defence. we should also bear in

if their expectations were to materialise. to put it in other words, central bank communication has to be two - way. the central bank talks and listens to financial markets at the same time. there are two points in this relationship which i want to highlight. first, by influencing asset prices and expectations of financial market participants, the central bank affects the very signals which it wants to use as input to its policy making. this has 1 / 4 bis central bankers'speeches become known as the “ echo chamber effect ”. as hyun shin from the bis has put it, “ the louder the central bank talks, the more likely it is to hear its own echo. ” 4 this is particularly prominent in times when the central bank gives strong forward guidance. ecb research has shown that in such circumstances, market expectations become “ cemented ”, i. e. they do no longer respond to news about the macro economy. 5 this is something we need to keep in mind when designing our communication strategy and when reading the signals from financial markets – the more forward guidance we give, the less informative are market signals for gauging the state and the expected evolution of the economy. a second point is that even if central bank transparency and communication has helped anchoring market - based inflation expectations, they do remain rather volatile. the volatility itself is a signal that is useful for us to understand. however, even if markets are volatile, central bank policy cannot be volatile. hence, we need to look through some of this volatility to get a feeling for the underlying pricing that would result in the absence of short - term market moves that are likely to revert quickly. the echo chamber effect and the inherent noisiness of market signals are reasons why we need to take the expectations that are priced in financial markets with a pinch of salt. this means that we need to also rely on other sources of information to ensure that we conduct a robust monetary policy. the incoming macroeconomic data are one such source. as we keep stressing, our monetary policy is data dependent, not market dependent : indications from market expectations cannot replace our policy judgement. another way of robustifying our analysis is to look for expectations beyond those expressed in financial market prices. 6 the importance of communication with the general public this brings me to the second group of actors i want to mention, the general public. central bank communication with the general public has only more recently gained the attention of academic research. also here, we