link in the transmission mechanism? ” bis working papers, no. 268, bank for international settlements, december. bis central bankers ’ speeches • at the same time, the global search for yield in a zero interest rate environment led to strong capital flows into the region, inducing increases in credit and asset prices. • the business cycle and financial cycle began to diverge : raising interest rates to quell financial imbalances could potentially put the real economy at risk. getting in all the cracks but not filling them a second reason why monetary policy may be ill - suited to address financial stability risks is that it is a blunt instrument. it may get into all of the cracks but some cracks may be just too big to fill. financial vulnerabilities are often not evenly spread across the economy. they tend to be concentrated in specific sectors, such as in real estate. monetary policy may be too blunt to address such specific risks and can cause significant collateral damage on the rest of the economy if it is calibrated to mitigate sector - specific risks. there is some empirical evidence that the cost - benefit trade - off in using monetary policy to lean against financial stability risks does not look promising. • kenneth kuttner and illhyock shim estimate that a 100 basis point increase in the short - term interest rate would reduce real housing price growth by only 1 percentage point in the following quarter. • lars svensson, drawing from the swedish experience, finds that the cost of leaning against financial stability risks is high – with inflation too low and unemployment too high. 5 at the same time, the effect of policy rate changes on household indebtedness is very small. • the imf estimates that hiking interest rates by 100 basis points for a year reduces the probability of financial crises by 0. 04 to 0. 3 percentage point at most. back to tinbergen : an enhanced role for regulatory policy so, we are back to where we started : if monetary policy has at best a limited role, what do we do with financial stability? • as stefan ingves put it recently : “ we deal with inflation, we keep an eye on the exchange rate, we do our best to reach our inflation target. but that means that somebody else has to deal with the problem we have in our housing market. ” 6 and that someone else could well be regulatory policy. and that includes both the oldfashioned microprudential variety as well as the “ new kid on the block ” –

of the financial markets in asia and the pacific does not match that of the real economy seems to be because the degree of regional financial integration is relatively low compared to that of trade integration, in other words, real integration. while the share of regional trade in total trades in asia and the pacific, by the way, in my speech this morning, asia and the pacific refer to 12 acc members of the region, has generally maintained a high level of around 49 % for the past ten years, the degree of capital integration is low, with the share of regional portfolio investment running at only around 10 %. ahuja and nabar ( 2012 ). elekdag et al. ( 2012 ). imf ( 2012b ). bis central bankers ’ speeches consequently, at a time of shocks external to the region like the global financial crisis, the real sector showed relatively high resilience thanks to its high regional dependence, but the financial sector even became an innocent bystander due to its heavy extra - regional dependence. more specifically, when the global financial crisis broke out, financial institutions in the us and the euro area embarked on massive deleveraging. hence asia and the pacific experienced large scale capital outflows, which were unrelated to pull factors, and consequent financial market unrest. in this regard, one step toward enhancing the resilience of the asia - pacific financial system is to further strengthen regional financial integration in such a way as to relieve the asymmetry between the degrees of financial and real integration. the initial target level for strengthening financial integration can be taken as that of regional trade integration. if so, risk sharing with offshore regions including the u. s. and the euro area will decrease, while risk sharing through the asia - pacific financial system will increase. 4 besides the risk diversification effect in moderating offshore shocks, closer regional financial integration will lead to consumption smoothing in regional economies, a typical effect of financial integration, and will also contribute to the easing of global imbalances and the development of regional financial markets. in the course of the euro area crisis, the asia - pacific is actually enjoying certain positive effects ― its financial system has become more stable along with a rise in regional financial transaction. this appears attributable to the fact that, while european banks have deleveraged out of asian emerging market economies, regional banks, such as those of japan and australia, have stepped up their lending to regional emerging market economies, which has helped ease the