, resource utilisation and monetary policy ” of 7 october 2010. bis central bankers ’ speeches the world is a big place … to start with, the rest of the world is a big place and we do not have the resources to produce detailed forecasts for individual countries in the same way as we do for sweden. instead we have to limit the number of forecast variables and focus on those parts of the world that are most significant to the swedish economy. for other regions we have to rely to a great extent on the assessments of other forecasters, although this of course does not mean that we copy their forecasts directly. another important aspect is that the forecasts for the different regions of the world must hang together in a consistent way. if, for example, we change the forecast for the united states then this also affects the forecast for the euro area ( and other regions ) and vice versa. this mutual interdependence is not always easy to manage but the preconditions have improved recently following the introduction of a new model for the international outlook. it is called the global projection model ( gpm ) and its main aim is to produce cohesive and consistent forecasts for different regions of the world. 2 the gpm also plays an important role when we want to produce different risk scenarios. … and changeable so, what regions of the world are most important to sweden? the region on our doorstep is of course very important. this primarily includes the euro area, but also the uk, denmark, norway and a couple of other countries in central and eastern europe. most of our trade takes place with this region. a region that has increased in economic importance over time is asia. the emerging economies in asia, led by china, have been the driving force behind the recovery of the global economy following the financial crisis. the importance of these countries for sweden ’ s foreign trade has also shown an increasing trend since the early 1990s. this of course means that it is now more important to monitor these countries than previously. the united states affects sweden through financial links finally, developments in the united states are always important even though in tradeweighted terms the united states only accounts for about 10 per cent. the reason for this is that the us economy often sets the tone for the development of stock markets and bond rates around the world. it is true that our knowledge and understanding of these financial links is limited3 but it appears to be the case that they play a particularly important role during slow

effects can be – seemingly small shocks can have large and systemic implications. economic fluctuations magnify and threaten the stability of the entire financial system. the channel of transmission can run through consumption or investment. • high levels of household debt affect output stability through the adjustment of consumption. evidence for the us shows that households with high levels of real estate debt cut back consumption in response to shocks to asset prices, thus amplifying the cycle. • firms with high levels of debt cannot smooth investment when an adverse shock hits. • high levels of public sector debt can be destabilising. as well government spending cannot cushion the effects of financial crises when public debt levels are already too high. these effects are further magnified if households, firms, and governments have borrowed from a banking sector which is insufficiently capitalised. adverse shocks then set into motion a downward spirals of asset valuations and prices that ultimately threaten the solvency of financial institutions. the destabilising effects of debt arise from its contractual features. standard debt contracts are insensitive to the borrower ’ s situation. after risks have materialised an adjustment to shocks can occur only through new lending or through haircuts on existing loans. in contrast, the value of equity adjusts if the situation of the borrower changes so that equity provides a risk sharing mechanism. in other words, equity as a claim on real assets has stabilising features compared to debt as a claim on nominal assets. the stabilising features of equity contracts have also been visible during the european debt crisis. in europe, debt finance has been more prone to capital flight than equity finance. furthermore, diversified cross - border equity holdings help detach consumption from business cycle fluctuations. cross - border equity allows more effective cross - border risk sharing and consumption smoothing. increased reliance on equity finance would be particularly beneficial in the european monetary union, where exchange rates cannot adjust to cope with regional macroeconomic shocks. 3. what are the policy implications? financial systems which rely more on equity rather than debt finance can be conducive to growth, and they tend to be more resilient to shocks. this suggests that there might indeed be a “ double dividend ” – financial sector reforms that contribute to financial stability also promote growth. viewed in this light, there are a couple of takeaways for policymakers and regulators. the first is that a more developed financial system is the basis for economic growth. however, our reform efforts should not be aimed at