This underscores my central point that a much more comprehensive approach to economic governance is now the priority for the euro area. And this means more economic and financial integration for the euro area, with a significant transfer of sovereignty to the EMU level over fiscal, structural and financial policies. Second proposition: Significant governance reforms have already been taking place Europe has responded to these policy, governance and market failures by undergoing a multi-year process of institutional reform. This leads me to my second proposition: that a much more radical change in euro area governance has taken place than many observers seem to acknowledge. There is a tendency to see the euro area response to the crisis as perennially behind-the-curve – as “too little, too late”. I concede that national authorities have not always been effective in stabilising financial conditions. But I also think this assessment lacks an appropriate benchmark. Observers expect a new “silver bullet” every few months and when one is not delivered, they are disappointed. But if we choose a more appropriate benchmark – say, the euro area in 2009 – a quite different picture emerges. The sum of the incremental steps taken since that date are, in fact, now a very big step. Take for example economic governance. The EU Council and European Parliament have agreed on a legislative package that significantly limits the discretion of national authorities, even when imposing sanctions on themselves. This includes a framework for monitoring a wide range of macroeconomic imbalances, also backed by sanctions.

Second, periods of higher productivity growth may lay the basis for high corporate earnings, heightened optimism and reduced risk awareness. At the same time, with strong productivity growth, inflation remains low. Banks that record low losses and solid results can increase lending without eroding their capital. Debt-financed investments may then lead to a faster rise in property prices. Third, strong international competition may contribute to curbing inflation during a period of strong economic expansion. Given that a conflict between the two goals may arise; how are financial stability considerations incorporated into monetary policy decisions? There seems to be widespread agreement among central banks, that extreme events which could threaten financial stability should be met by resolute use of monetary policy. For example, leading central banks made an effort to ensure continued liquidity in the markets in the aftermath of the terrorist attack on the World Trade Centre on September 11, 2001. As a consequence, the risks confronting the financial system were limited. However, risks to financial stability due to evolving financial imbalances are likely to develop over a long period of time. From this perspective, the question of whether financial stability considerations should be explicitly included in monetary policy is heavily debated, both in academia and within central banks. The answers diverge and international consensus has not yet been reached. One view is that an explicit and proactive monetary policy response to financial imbalances is neither desirable nor feasible. A number of concerns have been raised to explain this view.