day liquidity management impaired signalling of the monetary policy stance. • the situation is more problematic on longer money market maturities, where a substantial premium on official rates has emerged. central bank interventions have been effective in avoiding market disruptions, but they could not address the lack of disclosure underlying these tensions, resolution of which requires additional information of the size and distribution of exposures, an assessment of the impact on banks ’ balance sheets, and the completion of the process of risk repricing. all in all, by their prompt interventions the central banks were able to preserve orderly market conditions and avert a liquidity crisis, without endangering the markets ’ medium - term expectations in a period of volatility and generalized uncertainty. 4. 2. strengthening the foundations of the financial system the ongoing financial turbulence has not come as a surprise. for some time the supervisory authorities had been emphasizing the increasing strains, stressing the rise in sub - prime mortgage defaults in the united states and warning that investors ’ perception of risk might have changed suddenly, leading to abrupt portfolio adjustment and destabilizing effects. but the interaction between the difficulty to value sf products, the evaporation of liquidity and the “ rush to exit ” to reduce risk exposure could not have been foreseen, and nor could the speed at which the crisis spread across institutions and markets. to tackle the fragilities highlighted by the current turbulence, the financial community has put a number of initiatives in place in recent months. in particular : • at the request of the group of seven, the financial stability forum ( fsf ) is reviewing several important issues such as the management of risks – especially liquidity risk – by the institutions subject to regulation, the appropriateness of capital requirements, the full consolidation of the assets and liabilities currently kept off banks ’ balance sheets, and the transparency and valuation of structured financial products. • the eu finance ministers have asked the economic and financial committee to examine a number of issues raised by the recent turbulence, analysing them in a way that is complementary to the mandate of the fsf by taking a european perspective and covering slightly different areas, including the implications of the new capital requirements directive, which implements the basel 2 framework in the european union. in fact, it was not properly anticipated that commercial banks could be the weak link in the system : other financial institutions, hedge funds first of all, were thought to be more likely candidates to set off a crisis. to some extent, the

because while some of the “ transmission ” is somewhat mechanical, a lot of it isn ’ t. it depends on the behaviour and general frame of mind of the myriad households, businesses large and small, investors and financial market players and so on. the final linkages in the “ mechanism ” are those that connect changes in financial behaviour to changes in spending on real goods and services. and while high enough interest rates really can, more or less, force people to curtail their borrowing and spending, low rates can ’ t make them borrow and spend. they have to want to. the power of monetary policy to boost domestic demand depends importantly on some sectors of the economy being in a position to respond to lower costs of debt, higher collateral values, reduced incentives to save and so on, by spending more today, with confidence that their income in the future will allow them to service and repay the debt. which sectors would be available to lead such an expansion? in the broad, there are three. there are households, governments and firms. let ’ s think about each briefly. households being willing to increase their debt and lower the share of current income being saved was a striking feature of australia ’ s economic landscape from the early 1990s until just prior to the financial crisis. consumption spending consistently rose faster than income and the ratio of debt to income went from about 60 per cent in 1993 to 150 per cent by 2006. households are servicing that higher debt quite well – mortgages make up most of their debt and arrears are running at about one half of 1 per cent, which is low by global standards. but as i have argued before, it seems unlikely that household debt can rise like that again. nor would it be desirable. so while we can expect that household consumption spending can grow in line with income, or maybe a little faster given the rise in net worth over the past two years, the odds are against households being a driver of strong growth the way they were a decade ago. what about the government sector? most governments in australia are trying to strengthen their own balance sheets by containing the build - up in debt that has been occurring. 3 public final spending is scheduled, according to the stated intentions of federal and state governments, to be subdued over the next couple of years. in fact, it is forecast to record the most subdued growth for a long time. by and large then, the public sector is not in the phase of using its balance sheet to expand demand faster than normal. here