pools of sub - prime mortgages and that they would be revising their methodologies for assigning new ratings resulted in a loss of confidence in ratings and caused investors to fundamentally reassess the expected distribution of returns on a wide variety of structured finance products and the risks embedded in these products. these developments contributed to an increase in risk aversion and a substantial decline in market liquidity ( as illustrated in the chart on the right of slide 6 ) and resulted in a sharp drop in issuance volumes in structured credit and leveraged loan markets. one of the main channels of propagation and amplification of the financial market turmoil proved to be the off - balance sheet vehicles created by banks for clients or for themselves to invest in structured finance products. money - market fund managers and other investors apparently had underestimated the exposure they were incurring towards the risks in us sub - prime mortgages by purchasing asset - backed commercial paper ( abcp ) issued by these vehicles. box 8 of the review provides a detailed explanation of the various abcp structures and how they were affected by the market turmoil. ultimately, a liquidity squeeze was triggered in the unsecured interbank money markets because of the larger - thanexpected funding liquidity needs, or perceived future needs, of some banks with liquidity commitments to off - balance sheet vehicles, which had become unable to roll over a large share of their abcp in the market. at the same time, other financial institutions with liquidity balances tended to hoard them. box 9 of the review discusses the various reasons for this hoarding behaviour which has persisted until the present. the first is an adverse selection problem : counterparties with liquid balances have found themselves unable to distinguish between financial institutions that have sizeable exposures to structured credit products and those who do not. second, banks have hoarded liquidity for precautionary reasons because of heightened uncertainty about their own potential funding liquidity needs. third, money - market funds have also built up precautionary liquid balances to cover the risk of potential redemption requests by investors. i will not review here in detail the central bank operations that aimed to ensure the orderly functioning of the money market as they have been discussed on several occasions, and are summarised in the review. the ecb acted swiftly and decisively, with several refinancing operations, including initially operations of very short maturities and then of three - month maturity to address tensions in the

##oria or disillusion. ” he went on to draw some strategic conclusions, saying that : “ … we were given two eyes : one to watch money and credit aggregates and one to watch everything else. ultimately, these two policy perspectives are to be combined in a single strategy which subsumes them both in a unified – albeit complex – and robust framework for action. ” this was alien language in the homeland of the “ jackson hole consensus ”, which did not envisage a role for monetary analysis or financial disorder in monetary policy - making at all. it has become common parlance since, even there. at the same time, i have questions – many questions – on how best to integrate balance sheet considerations into policy - making in a way that does not undermine the best legacy of the pre - crisis era : our price stability mandate. let me elaborate. bis central bankers ’ speeches balance sheet restructuring previous crises have shown that prompt and decisive balance sheet repair after a period of excessive credit growth is the best way to restore sustainable growth. 1 post - recession growth may not even be significantly weaker than normal if the overleveraged financial sector aggressively cuts back excess credit in the recovery phase. 2 like balance sheet imbalances, structural impediments to growth and to an efficient allocation of resources are generally very relevant for the conduct of monetary policy and need to be tackled decisively. trying to stimulate growth through standard aggregate demand policies may be ineffective and, under certain circumstances, even counterproductive in balance sheet recessions, when structural breaks on potential growth predominate. 3 it is for this reason that the changes to euro area and eu governance introduced in response to the crisis are so important and need to be implemented with determination. the reforms undertaken in many stressed countries, especially those benefiting from official external assistance, should eventually lay the foundations for a robust recovery. most importantly, the steps being taken to create a banking union should help to address existing balance sheet problems. the initial focus is on banks ’ balance sheets. the comprehensive assessment of their balance sheets currently being done by the ecb is a critical element. thousands of supervisors are carefully scrutinising the books of the euro area ’ s largest banks. at the end of this process, the assets in banks ’ books should accurately reflect the economic realities. that means that the value of loans to over - indebted firms and households will be adjusted to reflect the actual debt servicing capacity of these debtors. incentives for