HIGHLIGHTS-BOJ gov:must not focus just on short-term price mov

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TOKYO Dec 22 (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Tuesday that the economy would be destabilised if the central bank guided monetary policy based on short-term price moves.

Following are key quotes from his speech:

MONETARY POLICY

"Looking back at price developments in the past quarter century, inflation gradually declined and it can be said that many central banks have been successful in terms of achieving price stability.

"However, in terms of financial system stability, the frequency of bubbles and financial crises has increased in the past quarter century, with major episodes including Japan's financial crisis following the burst of the bubble, the East Asian financial crisis, the credit bubble in the United States and Europe, and the recent global financial crisis.

"Moreover, ironically, all these bubbles arose in an environment of low inflation. While the causes of bubbles are complex, one major cause in all cases has been the emergence of a sense that liquidity is always available at the drop of a hat.

"While I do not think that accommodative monetary conditions alone can lead to a bubble, it seems that it also cannot be denied that expectations of a prolonged accommodative monetary environment lead to excessive leverage and maturity mismatches, thereby accelerating the generation of a bubble.

"Price stability is an extremely important policy objective for a central bank, but if a central bank conducts monetary policy by just watching short-term price developments, this may induce large economic fluctuations and result in harming price stability in the medium to long term."

BOJ'S ROLE IN FINANCIAL REGULATION

"The Bank of Japan Act clearly stipulates that one of the Bank's institutional objectives is 'to ensure smooth settlement of funds among banks and other financial institutions, thereby contributing to the maintenance of stability of the financial system.'

"The fact that the Bank of Japan during the recent financial crisis decided to implement measures that are extraordinary for a central bank, such as the purchase of stocks held by financial institutions and the provision of subordinated loans, was ultimately to achieve the objective stipulated in the Bank of Japan Act.

"While macroprudence is important, as a prerequisite for that, microprudence is also critical. As long as the Bank extends loans to financial institutions as the 'lender of last resort,' it needs to have sufficient knowledge of financial institutions' business performance and the quality of their assets.

"The Bank analyses and assesses the financial system as a whole from a macroprudential perspective by making use of information from individual financial institutions as well as information obtained through its daily monetary policy operations and the operation of the payment and settlement system. At the same time, the Bank strives to use the macro-assessment obtained in this way to inform its on-site examinations and off-site monitoring." (Reporting by Rie Ishiguro)