failure that occurs in a crisis when some economic agents deleverage substantially and the real interest rate cannot be set sufficiently low to underpin aggregate demand for goods and services among other economic agents. this theory seems to fit well with the situation in the us and europe after the financial crisis, where it has been difficult to set policy rates below zero. the result is amplification of the real economic costs associated with a financial crisis. individual borrowers do not take into account that more credit during good times increases the risk that the economy ends up in such a situation. bis central bankers ’ speeches the theory can be briefly summarised. the financial system left to its own devices creates excessive debt and excessive risk in upturns and insufficient credit in downturns, giving rise to credit cycles that amplify fluctuations in the economy. that is the background for macroprudential policy of banks. regulation should be tightened during goods times and relaxed during bad times. the mechanisms i have described are not new or unfamiliar. but it is only in recent years that researchers have managed to incorporate banking behaviour and economic policy in a dynamic general equilibrium model. these are the same type of models we use in the conduct of monetary policy. these models are also useful for macroprudential policy because we must understand both what is happening in the financial system and the real economy – simultaneously. important advances have been made in modelling systemic risk and how various instruments can be used. this will help us in our thinking – for example in distinguishing between credit growth that is good and credit growth that is bad. so, even though theory lags behind reality to some extent, it is useful. perhaps we can draw a parallel to isaac newton. the force of gravity as a phenomenon was hardly unknown before he formulated his theories, but they nevertheless proved to be very useful. a number of macroprudential instruments can be applied. in norway, finanstilsynet ( financial supervisory authority of norway ) has tightened the guidelines for sound residential mortgage lending. the risk weights for the capital banks must hold for residential mortgage loans have been adjusted upwards. liquidity buffer requirements for banks are in the pipeline and stable funding and leverage ratio requirements will be introduced. the ministry of finance has implemented a systemic risk buffer for banks and the biggest banks are required to hold additional capital. norges bank gives advice to the ministry of finance on the size of the countercyclical capital buffer for banks. many other countries have applied macropr

defenders of old truths see the light, but rather because they eventually die. 4 if we take a closer look at the basel iii framework, there are still signs of innovation. macroprudential policy is a new element of the framework, aimed at containing systemic risk in banks and financial institutions. for the first time, international banking regulation includes requirements grounded in the interplay between the banking sector and the rest of the economy. we must acknowledge that in the run - up to a financial crisis, the authorities, banks and other economic agents often confuse good times with normal times. strong growth in real estate prices, credit and tax revenues are perceived as normal. statistical filtering methods confirm that trend growth is high and that debt growth is sustainable. this time is different. we should know better – because we have fairly extensive knowledge about the economic background leading to financial crises. analyses, including our own, show that a rapid accumulation of debt almost always precedes a financial crisis. empirical studies document that high debt growth increases the probability of a crisis and results in a deeper crisis. 5 debt is at the core of all financial crises. real estate prices also rise rapidly ahead of a crisis. and it is warning signal when banks have to run to securities markets to finance growth faster than deposits alone allow them to do. systemic risk increases when imbalances build up. macroprudential policy is designed to address the systematic features of financial crises, strengthen bank resilience and curb the probability of a crisis. policy rules and transparency are aimed at avoiding complacency in good times. for example, the basel iii framework specifies that the ratio of credit to gdp should be a conditioning variable when setting the level of the countercyclical capital buffer for banks. the authorities must explain and justify their actions, or their inaction. if banking regulation is to be effective, not only must we be able to identify imbalances that are building up, but we must also understand the interaction between banks and other economic agents and how systemic risk arises. lessons from the 1960s and 1970s showed that detailed regulation was not very effective. if we are to intervene in the markets, we must understand how the market functions and why the market cannot be left to its own devices. this provides a basis for regulating markets and insight into regulatory effects. from the textbooks we are well aware of the ingredients of market failure – or the preconditions for regulating markets. environmental economics is often used as an example. if a poll