ernst welteke : financial market disturbances - a challenge for monetary policy speech by mr ernst welteke, president of the deutsche bundesbank, at market news international, london, 24 september 2002. * * * i. playing the financial markets has been anything but an easy thing to do recently. during the late 1990s, many investors enthusiastically embraced the idea of a “ new era ” of systematically increasing returns. now that the flaws in that concept have become evident, many of them have had to abandon a significant portion of their wealth. confidence in financial markets has been severely shaken. monetary policymakers are concerned when financial markets are as shaky as they are at present. monetary policy has a vital interest in the stability of the financial markets. the maastricht treaty assigns co - responsibility for the stability of the financial system to the euro - area central banks. the measure of responsibility assigned to them reflects the use that monetary policy makes of financial markets for the transmission of monetary policy. i would like to outline a number of major fields of responsibility in which financial market disturbances affect central banks. ii. let me first put the turbulence in the financial markets into perspective. the turmoil has been felt most keenly in the equity markets. since peaking in march 2000, major stock indices have been hit hard. the dow jones eurostoxx 50 and the german dax 30 have both roughly halved since reaching their all - time highs. the us standard and poor ’ s 500 index has shed about 40 per cent, while the technology - heavy nasdaq composite index has shrunk to almost one - quarter of its peak value. remember, in an environment of healthy corporate profits, soaring asset prices took price - earnings ratios up to hitherto unknown heights. equity markets looked overvalued, but the “ new economy ” paradigm enticed investors into not regarding them as overvalued. experience shows that a bubble can scarcely be identified with certainty until it bursts. the price - earnings ratios for major stock indices peaked at about twice their historical averages. individual stocks, especially from the bubble - plagued tmt sector, experienced much higher priceearnings ratios. for the eurostoxx, the s & p 500 and the german dax 30, the ratios are now close to their historical averages. the bubble has been deflated to a certain extent. booming fixed income markets mirror the faltering stock markets. as investors became more riskaverse, they switched from equities to bonds

their typical sale period rather than on the period the fund might need to sell them over. see page 54 of the november 2017 financial stability report. see the december 2015 financial stability report. and ‘ has corporate bond market liquidity fallen? ’ see page 27 of the july 2016 financial stability report. calculations based on sterling corporate bonds for the united kingdom, private non - financial companies in the euro area and corporate and foreign bonds held in the united states. uk and euro area data from 2008 to 2017 h1. us data from 2008 to 2017q1. all speeches are available online at www. bankofengland. co. uk / speeches if a fund is selling assets in timeframes shorter than typically need to obtain the market price, then redemptions result in a transfer of value to redeeming from remaining investors. when investors think others might redeem, they might face an incentive to run to the exit. this isn ’ t an issue in markets like equities where sale periods are typically shorter than the daily redemption term of the mutual fund. but for funds investing in corporate bonds and particularly less liquid assets like commercial property, it could be, in principle at least. unless it can be corrected through appropriate pricing arrangements in the fund, this structure might create an advantage to getting out first. existing ‘ swing pricing ’ arrangements go some way to doing this but may not be sufficient to correct it fully. the evidence suggests that investors in funds which offer short notice redemptions and that invest in less liquid assets tend to redeem more in response to a downturn in the funds ’ performance than those in more liquid funds. and the redemption behaviour of investors in bond funds seems to have become more sensitive as these markets have become less liquid. 19, 20 drawing these developments together, it ’ s possible that just as corporate bond markets have become less liquid, they may have become susceptible to greater selling pressure after a shock. we may have more of a mismatch of liquidity. that could amplify any price adjustment. none of this is conclusive and serious problems have not been caused by this in the past. but we have a duty to take the possibility seriously – to ask ‘ could it happen? ’ with markets having evolved so much in the past decade, the absence of problems in the past is no guarantee for the future. that ’ s why we ’ ve been developing simulations of the impact of this liquidity mismatch. the asset management industry has been a constructive