role in coordinating private expectations at times of severe uncertainty played a major part in the transition to today ’ s post - crisis world. the evolution of economic theory in response to the crisis a number of significant academic contributions during the 1980s had focused on the way optimal individual behaviour could change depending on what individuals expect other private agents to do. 7 the presence of this interdependence between agents, or as it is called, strategic complementarity, leads to multiple outcomes. each of these outcomes is a rational equilibrium, but ones that differ in their implications for social welfare. panic - based bank runs and panicbased sovereign debt crises are examples of policy intervention being needed to avert “ bad ” outcomes during a financial crisis. to an extent this is not a new idea for policymakers – central banks have been acting to stave off panic - based runs on banks for centuries. but the financial crisis has shown that severe financial frictions can exacerbate strategic complementarities. moreover, the financial sector nowadays is much more sizeable relative to the economy, and runs are correspondingly more costly. 3 / 7 bis central bankers'speeches advances in the literature have made strides in incorporating these ideas into macroeconomic models, thus to providing a clearer theoretical framework for these types of interventions. 8 economic research has also evolved in its thinking of how central banks should respond to an emerging crisis, particularly when their standard monetary policy instrument, typically a shortterm interest rate, reaches its effective lower bound. at the lower bound, monetary accommodation cannot be provided through further reductions in short - term interest rates and policy must become non - standard. one option is to rely on forward guidance, i. e. to promise to keep interest rates low for longer in the future. such commitments, if credible, lower longer - term interest rates and provide economic stimulus even if the current interest rate remains unchanged. 9while forward guidance is a useful instrument, recent research has highlighted that its effectiveness can be improved if combined with other non - standard monetary policies. 10 research in both academia and in central banks has therefore re - examined alternative monetary policy tools, including so - called quantitative easing ( qe ) policies. and here the newly developed models with financial frictions have been useful. 11 earlier studies based on the assumption of frictionless financial markets had concluded that qe is completely ineffective. the renewed focus on financial frictions clarified that this conclusion is unwarranted, once it is recognised that financial intermediaries

across the euro area. moreover, expectations fuelled a vicious cycle. tightening monetary conditions in countries affected by perceptions of redenomination risk put downward pressure on economic activity, exacerbating the perceived risk. such moves are a classic example of expectations leading towards an outcome that is non - optimal for social welfare. this is why we announced outright monetary transactions ( omts ) as an instrument that can support our monetary policy. the idea was for the ecb to purchase the sovereign bonds of countries affected by panic - based redenomination risk. by breaking the link between perceptions and downward pressure on economic activity, omts would aid in restoring the proper transmission of monetary policy across the whole euro area and support the recovery. omts were not used. that the ecb had the tool at its disposal was sufficient to anchor expectations at the “ good ” outcome. once unwarranted fears of redenomination were removed, sovereign spreads fell and banks were once again able to raise debt and equity funding. this played a vital role in fostering the euro area recovery that is currently under way. financial sector policies the greater awareness of the costs of financial instability and of financial frictions has also resulted in a revamp of financial sector policies. first, financial sector regulation and supervision are much stricter. the quality of regulatory capital has improved and its quantity has increased. in the euro area, banks have materially bolstered their capital positions, with the average common equity tier 1 ratio of significant institutions rising to 13. 5 % by end - 2016 from 7 % in 2008. the establishment of a new stress testing framework lends a further quantitative dimension to the process of ensuring that, even in a pre - defined “ stressed scenario ”, financial institutions should remain well capitalised and able to continue lending to creditworthy borrowers. second, policymakers have acquired new macroprudential tools to mitigate the effect of financial cycles on the economy. across the globe, authorities have imposed measures such as loan - tovalue and loan - to - income ratios, to reduce the endogenous link between credit and house prices. this new macroprudential approach to regulation aims to safeguard not just the solvency of individual banks but also the systemic integrity of the banking system and its ability to continue providing finance to the non - bank private sector. in addition to the overall global move to stricter regulation, there have been also a number of institutional improvements. in the euro area,