Introduction: piecing the puzzle together

The favourable global economic performance seen in recent years extended into the period under review. Global growth was strong and there were even welcome signs of better balanced demand. The US economy slowed somewhat, largely due to a weaker housing sector, while domestic demand in Europe, Japan and a number of emerging market economies picked up. Although output in many countries seemed to be close to potential, and commodity prices rose still further, overall inflation pressures remained muted. In this environment, there was a moderate tightening of monetary policies in many countries, although overall monetary and financial conditions remained highly accommodative. In part this was due to real policy rates remaining rather low, with associated effects on long-term interest rates. But it was also due to an increased willingness of lenders to advance credit to high-risk borrowers with less onerous conditionality than in the past. While the credit cycle has peaked in the subprime mortgage market in the United States, the expansion has continued in most other areas. As a result, global asset prices either continued to rise or were maintained at unusually high levels. Moreover, financing for the US current account deficit, as well as private capital outflows from the United States, continued to be available at terms that seemed to factor in expectations of only a very moderate further depreciation of the dollar.