. in this backdrop, there is no surprise that most of the central banks aim at maintaining low and stable inflation. central banks place more weight and demonstrate increased willingness on controlling inflation relative to output growth, and financial and exchange rate stability. it is important to acknowledge, however, that in practical policy making, adhering to revealed preferences is rather difficult. the reason is that central banks do not operate in a vacuum and require coordination with other policy making institutions, in particular the fiscal authority. in addition, the social and cultural make - up of a country and political economy considerations often require central banks to accommodate conflicting policies. in other words, sticking to an announced rule - based monetary policy can be difficult in practice ; “ enlightened discretion ” is preferred by most central banks. thus, sbp ’ s decision to focus on arresting the persistent inflationary trends is tantamount to a pro - growth policy, not a growth retarding one. c. monetary policy transmission mechanism the monetary transmission mechanism refers to a process through which monetary policy decisions affect the level of economic activity in the economy and the inflation rate. understanding the transmission mechanism of monetary policy is crucial for appropriate design and efficient conduct of monetary policy. as monetary policy actions affect policy variables with a considerable lag and with high degree of variability and uncertainty, it is important to predict the possible impact and extent of monetary policy actions on the real variables. thus, by its very nature, monetary policy tends to be forward - looking. it is also important to know which transmission channels are more effective in terms of transmitting changes in monetary policy actions to ultimate policy goals. since various financial sector developments particularly regarding introduction of new financial products, technological changes, institutional strengthening, and expectations about future policy, etc. http : / / www. federalreserve. gov / newsevents / speech / bernanke2006. 02. 24a. htm # f3 # mainnav can potentially change economic effects of the monetary policy measures, there is a need to regularly update, empirically test and reinterpret monetary policy transmission channels. the impact of monetary policy is perceived to transmit in to the real economic activity through five channels. • the first channel and most widely studied and understood channel of monetary policy transmission relies on the link between changes in the short - term nominal interest rate ( induced by changes in the policy rate ) and the long - term real interest rate that ultimately affect components of aggregate demand such as consumption and investment in

in order to ensure a rapid return to sound budgetary positions. this will not only facilitate the conduct of monetary policy over time, but is primarily in the interest of the countries themselves. the positive confidence effects of fiscal consolidation measures can be enhanced if such measures are part of a comprehensive structural reform agenda. i cannot spell out here in detail which reform measures would be appropriate. however, the main thrust of the necessary reforms is fairly obvious and generally agreed upon. besides, it has been clearly outlined in the recently revised lisbon agenda, which the ecb very much supports. what i would like to stress here is that the necessary reforms for increasing the euro area ’ s potential output growth and reducing the high rate of unemployment will also contribute to enhancing the effectiveness of monetary policy in maintaining price stability in the euro area and to minimising output volatility in response to adverse price shocks. reforms that foster productivity growth, improve the flexibility and adaptability of labour markets, and increase competition in the markets for goods and, in particular, services, will produce multiple benefits in terms of faster growth and lower output volatility in an environment of price stability. moreover, such reforms, together with prudent fiscal policies implemented at the national level, will help bring the higher inflation rates recorded in some euro area countries down to the average for the single currency area. the ecb ’ s monetary policy can and will secure price stability for the euro area as a whole. it is the responsibility of governments to ensure that the same high degree of monetary stability is attained at the national level, so that the competitiveness of the respective economies will not be eroded and faster growth can be sustained together with price stability. structural reforms are not only needed on the “ real ” side of the economy. reform and integration in financial markets are also crucial for economic welfare in europe. closer to home for me, they also have direct implications for the transmission of monetary policy impulses. the degree of financial integration is important in determining how effectively this transmission will work in practice. for example, it cannot be ruled out that single monetary policy decisions may sometimes be channelled to countries in a non - uniform manner on account of the fact that the financial system of the euro area – that is, financial institutions, markets and the infrastructure – are not yet fully integrated in all aspects. this brings me to the second part of my address : european financial integration. the state of financial integration in europe first of all, what do we mean by financial integration