the risk measures are drawn from the market and share some procyclical features. weights increase as credit risk rises so riskweighted assets will seem relatively low during tranquil economic times and relatively high during periods of stress. while there may be scope within pillar ii to address this, it is too early to know whether that can be used effectively. the combination of these market and regulatory effects have amplified risk taking during the boom and is now constraining risk appetite as financial conditions have deteriorated. policy responses since the crisis broke last summer, regulators, governments and central banks have come together in the financial stability forum ( fsf ) to analyse what has gone wrong and agree an international response. its recommendations have been approved by the imf and the g8 and include a range of measures to fill particular gaps or put right particular faults in the regulatory system by : • strengthening prudential oversight of capital, liquidity and risk management ; implementing basle ii and requiring more capital against, for example, off - balancesheet vehicles, securitisations and tail risk ; • enhancing transparency and valuation particularly for complex structured financial products and off - balance sheet vehicles ; • changing the role and uses of rating agencies, including by distinguishing ratings of corporates and structured products ; • strengthening the authorities ’ responsiveness to risk ; and • increasing the robustness of arrangements for dealing with financial stress ; ensuring central banks ’ operational frameworks are flexible enough to deal with extraordinary situations in money markets and mechanisms for dealing with weak or failing banks are put in place. more generally we are discussing in the fsf how the authorities can go further in moderating the financial cycle. of course monetary policy can play a role in this. one goal of monetary policy is to stabilise the economy in the face of shocks and central banks have always looked at credit and money growth as important indicators of the state of the economy. the rapid growth of credit in 2006 for example was one factor leading the mpc to start raising interest rates. however central banks have been wary of putting a lot of weight on disciplining financial markets by changing interest rates. famously alan greenspan asked “ but how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions..? ” there are two good reasons for care. first policy has to be appropriate for the whole economy ; the interest rates which would be needed to have a significant effect, say, on

, the blue brain project is setting out to reconstruct the brain piece by piece by building a virtual version in a supercomputer ( see http : / / bluebrain. epfl. ch / page - 52063. html ). farmer and hepburn ( 2014 ). hansen and sargent ( 2010 ). bis central bankers ’ speeches doing so for the next 12 quarters. japan has had no equivalent period of sustained growth at or above its pre - crisis rate in the past 25 years. as for deflationary threats, one guide is found in market measures of medium - term inflation expectations. at the 3 – 5 year horizon, consensus inflation expectations in japan have averaged around 1 % over the past 15 years. in the euro - area, inflation expectations have recently fallen to around 1. 8 % on deflationary fears. in the uk, meanwhile, inflation expectations have remained relatively stable at around the 2 % target throughout the crisis period. financial markets, at least, do not appear to be fearful of deflationary ghosts in the uk. a second uncomfortable scenario, the flip - side of the first, would be if inflationary pressures instead took hold. again, it is important not to dismiss this risk out of hand. monetary policy is in unknown territory. the most extraordinary dose of monetary medicine perhaps everwitnessed has been administered to a patient now whistling their way around the hospital ward. an over - reaction to the drugs cannot be ruled out. there are already some signs of the economy ’ s pulse quickening. the confidence fairy is back, after six years in rehab. levels of consumer confidence are now above 2007 levels, retail spending is rising at its most rapid rate since 2004 and levels of job security are at their highest since at least the 1990s. this feel - good factor is adding momentum to the uk housing market. businesses, too, have rediscovered their mojo. surveys of output intentions are close to record highs. quarterly employment growth is running at its fastest rate since the series began. surveys of skills shortages point to the possibility of upwards, if localised, wage pressures. output growth in 2014 q1 is nearly 1 % higher, and unemployment rate close to 1 percentage point lower, than the bank expected last august. if history is any guide, these errors tend to be positively correlated, upside as well as down. yet at the same time, the inflationary risks posed by such a scenario should not be overstated. as output and unemployment have surprised