Second, the welfaremaximising weight to be attributed to price stability also increases when international risksharing is obtained by means of cross-border holdings of nominal assets (e.g. non-inflation indexed bonds), as inflation would seriously distort effective risk-sharing. These interesting arguments bring me to the second part of my presentation on the potential implications of globalisation for financial stability. III. Globalisation and financial stability  Let me now focus on the effects of globalisation on the functioning of financial markets and institutions and the potential implications of these effects for the performance of the central bank task of safeguarding financial stability. This issue is both important and topical as the pace of global financial integration has accelerated in recent years and as the ongoing financial market turmoil has clearly demonstrated. Financial globalisation involves the increasing integration of financial markets and the growing presence of cross-border financial institutions. Financial globalisation is often defined and measured by the extent to which countries are linked through cross-border financial holdings. A commonly used indicator of financial globalisation is the sum of countries’ gross foreign assets and liabilities as a proportion of GDP. The evolution of this indicator documents the impressive dynamics of financial globalisation since the mid-1990s, especially for advanced economies (and to a lesser extent for emerging markets and developing countries). [see Chart 5]. In the euro area alone, the ratio of the sum of foreign assets and liabilities to GDP increased from 190% in 1999, the year the euro was launched, to 280% in 2005.

It is also impressive and relevant that the pace of financial integration for advanced economies was much faster than that of their trade integration from the early 1990s onwards. This is evidenced by the ratio of the sum of external assets and liabilities to the sum of exports and imports [see Chart 6]. Interestingly, this same ratio has been roughly stable for emerging market economies and developing countries over the same period. Finally, another pertinent indicator measures the extent and rapidly growing importance of the total cross-border bank assets and liabilities since the early 1990s, which increased fivefold from about 5 trillion US dollars in 1990 to almost 25 trillion US dollars in 2006. [Chart 7]. Globalisation and the development of financial markets The fast pace of financial globalisation has reflected, and at the same time has contributed to, the rapid development of financial markets. Both financial integration and development have been driven by several factors: deregulation, capital liberalisation, financial innovation and advances in communication and information technology. These factors have contributed, in a mutually reinforcing manner, to the exceptional growth of the overall size of financial markets relative to GDP [Chart 8] and the consolidation of the banking sector, with the emergence of large and complex financial institutions. They have also contributed to the exponential growth of new financial instruments, the adoption by banks of the “originate and distribute” business model and the increasing presence of new financial intermediaries.