short - term money market rates to long - term government bond yields. the low interest rates had an impact on investor behaviour. in particular, many institutional investors were bound by nominal or real return objectives. including acharaya, viral v, richardson, matthew : restoring financial stability new york 2009 ; fox, justin : the myth of the rational market, new york, 2009 ; tett, gillian : fool´s gold : london 2009 ; wessel, david : in fed we trust, new york 2009, see also gylfason, holmstrom, korkman, soderstrom, vihriala ; nordics in global crisis, vulnerability and resilience, helsinki 2010. as it was no longer possible to achieve these objectives by means of traditional investment instruments, investors began to look for higher - yielding assets. insurance companies, pension funds and other institutional investors, public and private alike, reverted to riskier investments. as the demand for riskier investments grew, risk premia fell to historic lows. so, money was cheap, nor was much compensation demanded for risk. the second element underlying the crisis was a lack of financial market transparency. interest rates were low and financial markets full of money looking for higher yields. because there was an inadequate supply of traditional, safe investment options, financial innovations – especially securitisation – came to rescue of investors. securitisation was the midas touch that turned even low - grade raw materials, such as subprime credits, into securities with the top ratings. in part as a consequence of securitisation, in part on account of capital adequacy regulation, increasing use was made of another type of financial innovation, ie derecognition and transfer of securities from financial institutions ’ balance sheets to special purpose vehicles. the “ shadow banking sector ” ballooned. securitisation and special purpose vehicles weakened the regulation of banks ’ capital adequacy and the quality of available information on financial markets. investors were unable to adequately assess the risks inherent in securitised assets, and risks were not always widely understood inside the banks either. similarly, bank balance sheets shed less light on banks ’ real exposures, as the bulk of the risks had been transferred to special purpose vehicles. impaired information quality led to the third element of the financial crisis, a variety of agency problems and moral hazard. because of the inability to assess the risks of securitised loans, the discipline needed to enforce credit

to keep the banking system operational, world trade shrank by 20 – 30 % within a few months and unemployment and government deficits went on the rise. the challenges for economic policy and economic thinking the financial crisis forced economists and economic policymakers to reconsider some basic issues : how to get through the crisis, and how to avoid a replay. the challenges are many, but i will pick upon just three of them. the first is to correctly understand the root causes of the financial crisis and to prevent their recurrence. the second challenge is to repair the damage the crisis has done to the public finances, and the third relates to the need to draw the right conclusions for economic analysis. so, the first challenge is to prevent similar crises in the future. the financial crisis taught policymakers many things – perhaps most importantly the holes in our understanding of systemic risk. the concept of systemic risk is not new as such, but the crisis revealed some new dimensions of systemic risk. before the crisis, it was not understood how multifaceted the links are between the global financial markets and that a sufficiently wide disruption could paralyse the markets. global financial markets did not collapse in october – november 2008. but the collapse was so near that such a risk could no longer be tolerated. efforts are now under way on numerous fronts to get systemic risk under control. on one hand, important revisions to the supervision of financial institutions are in process. the basel committee on banking supervision recently published its first consultation papers on the matter. these are truly significant initiatives – as evidenced by the scale of resistance to the proposed changes on the part of banks. another lesson from the crisis is that supervision of individual financial institutions is not enough. financial markets must also be supervised and regulated at the systemic or macro level. macroprudential supervision has already been under discussion for some 20 years, but it is only now that the tools and institutions for macroprudential supervision are being set up for the first time. the eu council has reached an agreement on the establishment of the european systemic risk board, and the european parliament is expected to consider the matter before next summer. there has been lively debate in various fora on the best instruments for controlling systemic risks. this discussion includes the possible role of monetary policy. there is talk about “ leaning against the wind ”. this idea meets with two types of opinions within the central banking community. on one hand, there is wide agreement that monetary policy should take greater account of certain monetary