also contributed to the relentless search for yields and the increasing appetite for risk. in fact, in the annual economic symposium on “ housing, housing finance and monetary policy ” held by the federal reserve of kansas city at jackson hole during august 30 - september 1, 2007, professor john taylor ( of taylor rule fame ) argued that the fed had followed an excessively loose monetary policy between 2002 - 2006. the combination of sustained low inflation accompanied by accommodative monetary policy worldwide could have generated excessive confidence in the ability of central banks and monetary policy to keep inflation rates and interest rates low indefinitely, leading to under pricing of risk and hence excessive risk taking. this result is analogous to the excessive foreign borrowing undertaken by private sector borrowers and banks in east asian countries when exchange rates were seen as relatively fixed, and hence their risk perceptions were low. it may be ironic that the perceived success of central banks and increased credibility of monetary policy, giving rise to enhanced expectations with regard to stability in both inflation and interest rates, could have led to the mispricing of risk and hence enhanced risk taking. yet another view is that more than success or failure of central banks, the repeated assurances of stability and guidance to markets about the future path of interest rates, coupled with the availability of ample liquidity was an invitation to markets to underprice risks. this view, consequently, puts the blame on those central banks who failed to give space to markets to assess risks by eschewing surprise elements in policy. it is possible that with increased globalisation resulting in the containment of prices of tradable goods during this period and hence of measured inflation, the excess liquidity has shown up in elevated asset prices worldwide, along with increased cross border capital flows in search of yields. easy monetary policy itself may have generated a search for yields that resulted in a dilution of standards in assessing credit risk. the desirability of using monetary policy tools, and judgements regarding the adequacy of such tools, to meet asset price movements is yet another relevant factor in this regard, in so far as most central banks did not address this issue. as some withdrawal of monetary accommodation commenced in response to perceived or visible inflationary pressures, the sub - prime crisis revealed these vulnerabilities starkly as confidence plunged, markets froze and triggered off panic among investors and lenders regarding their inability to value complex risky assets and structured derivative products. with the deterioration in credit confidence, banks have been forced to advance loans

to their off - balance sheet " special investment vehicles ( sivs ) " which uses up their capital thereby rendering other borrowers credit constrained. thus, it can be argued that it is the combination of low real and nominal interest rates brought about by the lowering of inflation, accompanied by the abundance of liquidity induced by accommodative monetary policy which lies at the roots of the current crisis. in this sense, the sub - prime is a symptom rather than a cause. arguably, the outcome could have been quite different if, for instance, interest rates declined on the back of ebbing inflation but there was no accommodation in monetary policy and therefore no excess liquidity. whereas this view has been put forward by many commentators and analysts, there is also a persuasive opposite view, as best articulated by alan greenspan in a recent interview on the occasion of the release of his book ( financial times, september 17, 2007 ). he argues that the great moderation in inflation could be attributed to real economy phenomenon in addition to any monetary policy measures. first, the long run of productivity growth that has been observed in the us in the late 1990s and till recently in this decade has clearly been an important factor dampening inflation. second, globalization and the addition of a billion new workers in china and india have dampened wage growth worldwide and hence inflation. whereas he agrees that the fall in long term rates provided the initial gain in house prices, he does not accept that these low long term interest rates can be attributed to the extended us fed policy of low policy interest rates. as evidence, he points to the absence of any effect on long term interest rates when short term policy interest rates were indeed raised. so the jury is out on the extent of monetary policy effects on extended long term interest rates and hence elevated housing prices. as an aside, it will be interesting to explore as to whether the low interest rate regime was fully justified. critics argue that the fed should have tried harder, raising rates sooner and faster. in his response, mr. greenspan is quoted in the financial times ( september 17, 2007 ) as saying that such a policy response would not have been acceptable " to the political establishment " given the very low rate of inflation and " the presumption that we were fully independent and have full discretion was false ". one issue that confronts us is why has the turmoil originated in the credit market and then spread to money markets and debt markets with such great rapidity