be identified, as the economy becomes more information - driven, service - oriented, and network - intensive. 9 a case in point is financial services consumers purchase from financial institutions. financial services are about risk assessment. as our experience of the financial crisis shows, however, such risk assessment turned out to be inadequate. if an ideal quality adjustment method had been available to us, quality adjusted prices of financial services would have increased reflecting their declined quality. such a statistical treatment has hardly been implemented in practice, and the situation seems to remain the same in the future. policy responses after the burst of a bubble the second difficult challenge is that a policy response, if successful in the short term, does not necessarily imply a success in the long term. central banks moved swiftly and aggressively, countering a serious economic downturn stemming from the burst of the bubble. we have to be aware that such policy responses could cause other risks, including the emergence of an asset - price and credit bubble. given the increase in the frequency and magnitude of bubbles since the 1990s, i mentioned earlier, we need to have a longer time horizon to tell whether a policy response will succeed or not. shirakawa ( 2010 ) points out a mechanism of so - called the “ cycle of confidence ” behind the bubble and financial crisis. see varian ( 2001 ). central bank in democratic society the third difficult challenge is related to the fact that a success in policy responses poses a new problem as to what responsibility a central bank should bear in democratic society. confronted with the financial and economic crises, central banks in major countries have all introduced unconventional policy measures. in that regard, the bank of japan was the first to experience a financial crisis, and, thus, was the first to employ unprecedented measures. since the late 1990s, the bank of japan has been moving aggressively as a lender of last resort, including the funds provision to the securities firm. the bank of japan also launched various unprecedented measures, such as a stock purchase program from financial institutions and the outright purchase of asset backed commercial papers and asset - backed securities. thus, it is my regret that innovations in the bank of japan ’ s policy responses have not been well recognized. in fact, under the current financial crisis, major central banks have also taken unprecedented policy measures, just like the bank of japan did. unconventional policy measures taken by a central bank involve quasi - fiscal policy elements, such as potential taxpayers ’ burden incurred by a loss from such operations, and intervention in resource allocation

of problems. technological innovation in the capital market made the services offered by banks less attractive, and pressure from abroad for financial deregulation intensified. as a result, banks became strongly aware of the decline in their franchise value, which gave them a strong incentive to pursue risk - taking activities to maintain and improve their earnings. furthermore, deregulation of the traditional segmentation of business areas and banking organization proceeded only gradually, thus making it difficult for banks to develop businesses that might open up new opportunities for profits. the result was excessive risk taking in lending which was their traditional business. furthermore, financial institutions can temporarily prevent a fundamental deterioration in profitability from surfacing through aggressive lending. this kind of behavior and a rapid rise in asset prices during the emergence of the bubble that accelerated credit expansion, worked together to amplify the excess in the business cycle. during the bursting of the bubble in the 1990s, japanese banks simultaneously faced two problems : the non - performing asset problem and a further rise in pressure stemming from global competition. the interaction of these two problems further delayed improvements in financial system functions, and was a significant factor behind the stagnation of japan ’ s economy in the following years. major japanese banks found it difficult to make sufficient high - tech related investments due to capital constraints, and had to divest themselves of profitable overseas subsidiaries. this had a significant adverse impact on the competitiveness of investment banking, which has tended to yield the highest returns, and perhaps further delayed reconstruction of the medium - term profitability of banks. furthermore, economic globalization promoted the convergence of factor prices, including property prices, and made reconstruction of the financial system more difficult by amplifying pressure stemming from asset deflation. what lessons can the central bank learn from recent changes in the financial system and the experience of financial crises? first of all, innovations in information technology and globalization are ongoing phenomena and will likely continue to change each country ’ s economy as well as its financial system at a rapid pace. for a central bank, this leads to increased uncertainty in the environment surrounding the conduct of monetary policy. a case in point is the argument that i made earlier on “ overbanked ” market. such an argument is often made regarding the financial system in countries like japan and germany. if this argument is correct, it is envisaged that these countries would witness the rapid reduction of both deposits and loans, and the increase in such instruments as mmfs. in japan, we hear conflicting views on the issue :