peter praet : financial cycles and monetary policy speech by mr peter praet, member of the executive board of the european central bank, in the context of a panel on “ international monetary policy ”, beijing, 31 august 2016. * * * i would like to thank federic holm - hadulla for his contributions to this speech. financial asset prices and credit creation in the global economy are characterised by pronounced and recurrent ebbs and flows – a pattern we have come to refer to as the financial cycle. 1 in my remarks today, i will discuss the role of monetary policy and other policy domains in steering this cycle. financial cycles derive from two closely related factors. the first is a natural tendency towards occasional bouts of “ irrational exuberance ” – for instance in response to promising scientific discoveries or technological advances – that lead investors to radically upgrade their future income expectations. the second factor is the capacity of financial intermediaries to transfer this expected increase in future income into the present through credit creation, thus establishing a financial upswing that constitutes the real - world counterpart to the upswing in economic optimism. but when some of the expected benefits that investors ascribed to the new discoveries or technologies do not come to pass, this process goes in reverse. a period of collective retrenchment ensues and the financial cycle enters into a downswing. such cycles, while certainly painful for individual investors, are not necessarily harmful for the economy as a whole : productivity growth and technological progress rely on investments in promising but risky ventures, which are driven by entrepreneurial zeal and often financed by credit. as such, financial exuberance often acts as a by - product of economic progress. 2 but this is not always the case : some asset price bubbles, for example in housing markets, may go along with a misallocation of resources and lower productivity growth. and in all instances the flip - side of financial exuberance is an increased risk of regular, and potentially violent, reversals 3 – a pattern we have seen repeatedly in history, going back at least to the dutch tulip mania in 1636. 4 hence, for policymakers concerned with financial stability, financial cycles present two related questions. first, how should they identify when it is justified to intervene in the cycle? and second, if intervention is justified, which policy domain should act? criteria for policy intervention a key criterion to identify the case for pre - emptive policy intervention is the presence of systemic negative externalities.

. you mean deliver more than 1 % deficit reduction per year? a. “ for some it is a necessity that has already been agreed upon by the ecofin. ” q. greece has had problems ever since the beginning of the euro. does that mean sgp - sanctions are not effective? a. “ in that particular case, it ’ s up to the euro group, the commission and the greek authorities to first of all improve definitively the way the figures are produced, the way they are computed, the way they are certified and stamped by the national authorities and by the european authorities. that is essential. we must work on the basis of reliable figures. on top of that the stability and growth pact has to be applied fully and rigorously for all countries, as i said earlier. ” q. some economists call a loose monetary policy the real cause for the crisis. in let ’ s say 2005, did you see the danger of that policy? a. “ the governing council of the ecb has demonstrated its dedication to its mandate during this period. we refused to decrease rates when we were called upon to decrease rates, in the beginning of 2004 by the chancellor of germany, the president of france and the prime minister of italy. in december 2005 we decided to increase rates. this decision was criticised by ten out of twelve governments that belonged to the euro area at that time. not by the dutch government, by the way. the international institutions and many economists were calling upon us not to increase rates. in 2006 and 2007 we mentioned publicly that global finance had to prepare for a correction due to a marked underassessment and underpricing of risks. i was public myself in january 2007, before the start of the turbulences, expressing the sentiment of most central bankers, who were diagnosing this underpricing of risk. ” q. some economists say interest rates are so low for so long, that the new bubble is being born now? a. “ the governing council of the ecb has always taken decisions commensurate with the challenges we had to cope with, and quick and expeditious when exceptional circumstances were requiring it. at the same time we have always been dedicated to our mandate and did not hamper, in any respect, our capacity to deliver price stability in the medium term. we can tell our 330 million fellow citizens : you can have confidence, we will deliver price stability. our credibility has helped us solidly anchoring inflation expectations which