excessive house price increases and the build - up of large current account imbalances, in particular in the united states but also in other regions, including some euro area countries. although the degree of policy expansion was not the same across world regions, in sum excess liquidity emerged at the global level. the fact that global excess liquidity did not immediately show up in consumer price inflation gave a false sense of security to financial market participants, encouraging increased risk - taking. moreover, while expansionary policies could not eliminate the need for an adjustment of macroeconomic imbalances, they were able to postpone the adjustment by several years, thereby encouraging the further growth of imbalances. second, inadequate microeconomic policies including lax regulation facilitated the emergence of financial market excesses. the most obvious area of policy failure is the setting of inadequate incentives in housing markets in some countries. a policy of maximising the number of houseowners, irrespective of affordability, is simply not sustainable. in addition, the absence of regulation in some areas of the mortgage market together with the emergence of the originate - to - distribute model created incentives for the provision of loans beyond sustainable levels. also, the design of capital adequacy requirements and accounting standards resulted in procyclical lending behaviour, which acted as an automatic destabiliser of the financial system. another aspect that will have to be carefully studied in the coming years is to what extent there is a causal relationship between financial deregulation and subsequent financial crisis. while financial deregulation is intended to promote innovation and thereby economic growth, it can, if ill - designed, result in imprudent behaviour instead. finally, financial market participants themselves have been an important factor driving the financial excesses of the past few years. the introduction of largely unregulated and intransparent financial instruments together with the rapid increase in off - balance sheet activities has undermined the trust in the financial sector. some of the new activities have clearly not been undertaken with a view to making financial markets more complete and to increasing risk - sharing opportunities. instead, they helped to circumvent regulated areas and to maximise short - term profits. ill - designed compensation schemes played an important role in this shortening of horizons among financial market agents. the incentives provided by these compensation schemes were such that short - term benefits translated into huge compensation increases while there was no liability at all for long - term losses. this asymmetry created incentives for

1997? in october that year, the world economic outlook published by the imf projected that world economic growth would continue at above 4 per cent per annum for the balance of the decade. this projection was made in the knowledge of the emerging problems in asia, but in the expectation that relatively robust growth would continue in the united states and europe. a few weeks later, the south korean economy was clearly in serious difficulty, but the mean of the november consensus forecasts projected that industrial production in korea would grow by almost 8 per cent in 1998. industrial production in japan was projected to grow at what seemed like a very modest 2 per cent this year. we were suspicious that perhaps the consensus forecasts were not picking up the seriousness of the deterioration in the world situation. for the first time, we deliberately departed from our traditional use of the mean of the consensus forecasts, and instead used a pessimistic sub - set of those forecasts. we had a hunch that the situation could turn out even worse than these numbers suggested but, with the overwhelming majority of international forecasters continuing to project strong growth in key markets such as australia, the united states, and europe, we stayed with that pessimistic sub - set. even though, with the wisdom of hindsight, it is clear that the growth we projected for the new zealand economy in 1998 was too optimistic, that is not the same as saying that monetary policy itself was flawed. every quarter, the bank produces a new quarterly projection, and adjusts its position in the light of new data. perhaps of even greater importance, the bank allows financial markets very considerable leeway to adjust monetary conditions in the light of new data between those quarterly projections. the real issue is not whether the bank ’ s projections were absolutely correct ; they will never be. rather the issue is whether the bank allowed monetary conditions to evolve appropriately in the light of new information, and i believe that we did. over the 10 months since december 1997, the easing of monetary conditions has accelerated so that today monetary conditions are the equivalent of almost 10 percentage points easier than they were in december 1997, and more than 9 percentage points easier than they were projected to be now, back in december 1997. of course, not all of that easing has been through reduced interest rates : the exchange rate has fallen substantially also. but 90 - day interest rates today are at levels last seen in early 1994, and indeed, apart from that brief period in early 1994, new zealand has