christian noyer : some thoughts on current financial turbulences speech by mr christian noyer, governor of the bank of france, at the euro fixed income forum, paris, 4 december 2007. * * * these are difficult times for policy makers. financial turmoil has created macro economic uncertainties. events are still unfolding. in those circumstances, i thought best to have a look at the dynamics driving recent turbulences ; then describe potential consequences for the economy ; finally make remarks on challenges for central banks and best ways to preserve and restore international financial stability. the dynamics of the crisis • i will start with a paradox. by any measure, we are facing a huge shock in financial markets. spreads in some segments of credit markets have widened with unprecedented speed and volatility. even more significantly, interbank markets in large industrial countries have been severely disrupted, for the first time in fifty years, more disrupted in fact, and for a longer period, than after september 11, 2001. • and yet, the losses themselves, while significant and spectacular for some institutions, would not seem to pose a major risk to the health of the financial system. current median estimates put the direct cost of subprime defaults around 250 billions usd. this is a little less than one year of profits for the 40 major financial institutions in the world. most notably, the turbulences occurred in a very favorable macro economic environment. why is there such a disproportion between the cause and the effect? at the aggregate level, most observers – including the banque de france – would point to a prolonged period of excessive risk taking in credit markets fueled by liquidity expansion at the world level. this was most apparent in the strong developments of lbos, mostly financed through leveraged ( i. e. with weak covenants ) loans. according to this interpretation, we may be witnessing the burst of a credit bubble. but there is also a deeper, more structural, element to the current turmoil. this crisis is the first in a disintermediated credit world. while, previously, loans were originated by banks, kept on their balance - sheet and monitored for the entire life of the loan, the process is to a large extent dissociated today : the loan is originated by a first entity, then bundled together with other loans as a structured product by another entity, then sold to final investors. these developments were expected to bring important benefits to the financial system and the broader economy : o as part

food and energy, which logically has a strong and permanent impact on inflation. furthermore, by strengthening the magnitude of global shocks in relation to more specifically domestic shocks and favouring the international transmission of the latter, globalisation introduces a much greater synchronisation of inflationary cycles between countries, with the ensuing risks of amplification. overall, the effects of globalisation have ceased – probably in the long term – to be spontaneously disinflationary. the second topic that i wish to discuss concerns globalisation and financial innovation. there is, in my mind, no doubt about the long - term benefits of the financial innovation process that we have been witnessing over the past twenty years. however, we can also see that it may be accompanied by cyclical developments and structural changes that could potentially prove to be disruptive for monetary policy. monetary and financial conditions are simultaneously influenced by central bank decisions, but are also increasingly affected by sometimes exogenous trends in asset prices and the pricing of risk. the monetary policy transmission mechanism is more fraught with uncertainty and less " linear " than it used to be, as shocks on asset and risk prices introduce discontinuity into financing conditions. these developments underscore two interesting issues in particular that i would like to briefly consider. the first concerns monetary policy responses. it will have escaped nobody ’ s attention that these responses are not identical across all countries. in my view, this reflects different situations more than divergent approaches. all of the world ’ s economies are not affected in the same way by property market shocks or developments on credit markets. in particular, we can observe that the distribution of credit remains very dynamic in europe and that, in most euro area countries, property markets remain relatively stable. more fundamentally, it seems to me that developments in the economic and financial context of globalisation bear out and reinforce the importance given to what, in eurosystem parlance, we call monetary analysis, i. e. the examination and analysis of the main monetary and financial aggregates. we derive three major benefits from our monetary pillar. first, it favours the anchoring of long - term inflation expectations, which is essential when, as is currently the guilloux s. and kharroubi e. ( 2008 ), “ some preliminary evidence on the globalization - inflation nexus ”, working paper series n°195, january case, instantaneous pressures are strong. second, it constitutes an integrated framework for the analysis of financial and