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Monetary and Financial Stability: Lessons from the Crisis and from classic economics texts

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My remarks today will be focused primarily on features of the developed world’s financial system which led to the crisis of 2008 and to the Great Recession that followed, from which we are only slowly and painfully emerging.

But I will also draw some implications for optimal policy in emerging countries, posing the question: how should you foster the development of financial systems which serve the vital needs of your economy, while avoiding some of the mistakes which have wreaked such havoc in the developed world?

The crisis of 2008 was essentially a crisis of excessive leverage, the result of a steady build up of excessive debt contracts over several preceding decades. That excessive leverage led to bust. And after the bust, deleveraging creates deflationary pressures which we cannot offset by conventional monetary policy alone, since interest rates are at the zero bound.

So my purpose this evening is to explore both the drivers of financial instability which led to the crisis and, more briefly, the challenge of monetary and macro-prudential policy in the face of the deleveraging which has followed.

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