illustrated the potential of markets for providing funding to the real economy ( particularly to the most innovative sectors ) ; but it also demonstrated the tendency of markets to over - react, moving from excessive optimism to disproportionate pessimism, with the ensuing negative consequences for the behaviour of firms and households. as a result, financial authorities have been confronted with boom - bust episodes which must be carefully monitored, since they could affect global monetary and financial stability. i would like therefore to consider two issues here : • firstly, experience suggests that financial cycles may have recently tended to amplify relative to business cycles ; what are the driving factors behind this move ; • secondly, what are the possible policy implications of this development, from both a monetary and financial stability perspective. 1. experience suggests that financial cycles have recently tended to amplify relative to business cycles. a. what are the major features of these amplified financial cycles? let us first consider credit cycles. there is no doubt that the amplitude of credit cycles is usually larger than that of business cycles. what is however noticeable here is that, over the last three decades, business cycles have been less frequent and less amplified while credit cycles have tended to remain fairly marked. thus credit cycles have been amplifying in relative terms compared with business cycles. asset price cycles have also become more pronounced even if the fixed interest rate markets have a tendency to be somewhat contra - cyclical. • in the last two decades market forces have indeed tended to cause clear misalignments between equilibrium and actual asset prices. stock markets in particular have experienced this phenomenon. but in foreign exchange markets as well, prices have also tended to diverge substantially from their “ equilibrium level ”, although those divergences have been contained through fruitful gvii cooperation during the last 15 years. • in addition, some markets have seen an increase in volatility and frequent volatility peaks. although cyclical moves should be clearly distinguished from volatility, the latter may in some circumstances exceed what can be considered optimal, making the price determination mechanism less efficient and thus contributing to misalignments. • moreover, as demonstrated by a number of financial crises during the last two decades, contagion among countries and across financial markets has been frequent. as a result, investors have faced asset price fluctuations that might be more synchronised than before. • lastly, the connections between credit, asset price and business cycles have tended to amplify cyclical

swings. credit, in particular, has played an increasing role in asset price fluctuations. initially observed during the “ speculative bubbles ” of the 1980s and early 1990s, this trend has persisted. another example is provided by boom - bust cycles in asset prices and credit activities, which have often been associated with sharp economic contractions. in sum, the recent period has experienced some amplification of financial cycles, compared with business cycles. b. what are the factors underlying this possible amplification of financial cycles? let us first consider credit cycles : • the first factor in play is the behaviour of banks, which is closely linked to their environment. some of them may have tended to artificially increase their return on equity through higher leverage or low provisioning during upswings. as a consequence they tend to become more fragile in the downward phase of the cycle. in parallel, investors have become more reluctant to invest in the banking sector when profit expectations are low, making it difficult for banks to raise new funds. banks ’ soundness therefore tends to be more correlated to economic fluctuations than in the past, contributing to the amplification of the credit cycle. • accounting regulations so far may also contribute to amplifying credit cycles to some extent. in most financial centres, current provisioning behaviour does not allow banks to take a forward - looking view of their risks, as accounting and tax rules only accept loan - loss provisions for impaired loans. such a regulatory environment may amplify the credit cycle, contributing to low provisioning and over - lending during upswings and paving the way to sharp corrections during downswings. using full fair value accounting for loan portfolios might further amplify credit cycles by increasing the volatility of banks ’ earnings. • prudential rules may also have been unable so far to always prevent these developments. current capital adequacy rules are not risk - sensitive ; as a result, credit deterioration does not require additional regulatory capital unless loan losses erode the capital base under minimum requirements. as most banks – particularly large ones – have capital far beyond the prudential minimum requirements, they can bear a reduction of their capital base without being compelled to restrict their credit granting. therefore, capital ratio is not pro - cyclical as such. the point is that, even while capital requirements are fulfilled, losses can reduce banks ’ own funds at a time when capital issuance is difficult or costly ; in such a juncture, some analysts argue that banks may be