jaime caruana : concluding remarks - conference on “ central banks in the 21st century ” speech by mr jaime caruana, governor of the bank of spain and chairman of the basel committee on banking supervision, at the conference on “ central banks in the 21st century ”, hosted by the bank of spain, madrid, 9 june 2006. * * * it is my pleasure to participate in this concluding session of the conference and to be accompanied at this table by pedro solbes. i hope you found the presentations and discussions inspiring and motivating. i certainly did. we are now witnessing some profound changes in the way our societies organise their economic relationships, and these naturally pose new challenges to central banks, regarding both their role of monetary policymakers and their responsibility to preserve and foster safer and more efficient financial systems. over the last two days we have discussed some of the underlying forces of change and their implications for the design of sound monetary policy and financial architecture, including the question of how best to arrange payment and security settlement systems. let me briefly elaborate on some of the issues raised at the conference which i found particularly interesting. i will first reflect on the difficult question of how monetary and financial stability relate to each other and then move to some particular issues of special interest for a currency area, such as economic and monetary union ( emu ). monetary and financial stability the global financial system has developed at an unprecedented pace in the last two or three decades. during this time, many countries have undergone significant processes of financial liberalisation that have contributed to deeper and wider markets, in terms of both the number of participants and the assets traded on them. in the international sphere, financial liberalisation has led to a growing number of countries gaining access to global capital markets and to a stepping up of the economic and financial links among different regions. technological progress has also played an important role. the ability of market participants to obtain and process vast amounts of information almost instantaneously and to conduct complex transactions at low cost has grown enormously. in short, all these changes have significantly increased the possibilities for risk - sharing among economic agents. and, as such, there is ample consensus that this process of financial deepening brings tangible benefits for businesses, households and governments alike. there is little doubt either that this phenomenon will continue its course over the foreseeable future. in parallel to the changes on the financial landscape, we have also witnessed a remarkable performance by our monetary policy frameworks in terms of attaining and maintaining low

, an otherwise beneficial context of price stability and low financing costs might sometimes sow the seeds for the emergence of financial imbalances. this latter, somewhat ironic conclusion has spurred a recent debate on the role to be assigned to monetary policy as an instrument of use in correcting financial and real estate market excesses. should central banks react to asset prices over and above their direct effects on purely monetary goals, such as inflation? the answers vary depending mainly on the confidence that one places in the ability of central banks to detect price misalignments early and to undo them without causing major damage to the economy. i tend to think that while in normal conditions monetary policy should react only to changes in economic variables insofar as they bear some influence on inflation dynamics, there are exceptional circumstances in which policymakers have enough signals to conclude that the economy, as a whole, is facing significant risks, thus warranting a more pre - emptive policy approach. this pragmatic view is consistent with the idea that monetary policy decisions should be based not only on the most likely scenarios but also on other, less probable ones which, however, may have far - reaching implications for the entire system should they materialise. certainly, an abrupt asset price correction pertains to this class of low - probability event that may ultimately entail significant costs for a country ’ s welfare. more importantly, to place this approach to monetary policy in its right place, it is critical to recognise that some of the risks inherent in the financial sphere should first be the subject of an appropriate prudential framework. it is no exaggeration to say that any concern about unbalanced market developments is, at core, a concern about a problem of inappropriate risk management. this statement applies to the case in which, due to over - optimism or short - sighted behaviour, market participants fail to appreciate the true risk of their investment or lending strategies. yet even if their behaviour can be thought as being fully rational from an individual perspective, nothing ensures that the final outcome will not convey important risks at a systemic level that are not properly internalised by single agents. as a result, a portion of the marked volatility and procyclicality of some key financial variables, like asset prices and credit, may be understood as a reflection of individual and collective risk misjudgement. hence, there is much to be gained in terms of greater resilience and efficiency of the financial system through the design of regulatory and supervisory