area non12 emu countries = share of intra euro area nondomestic assets in total euro area holdings. domestic assets in total euro area holdings. other country groupings = share of euro area other country groupings = share of euro area assets held by non - euro area residents in total assets held by non - euro area residents in total non - euro area residents ’ holdings non - euro area residents ’ holdings one important conclusion can be drawn from this analysis. by reducing the barriers for cross - border portfolio allocation, emu has had an impact on regional financial integration not only among euro area member states, but also vis - a - vis other european countries, which is particularly sizeable in the fixed income market. this brings me on to one of the key achievements since the creation of emu : namely, the fostering of european financial integration, which goes well beyond the mere elimination of the exchange rate risk. 12 by providing a higher degree of financial integration, emu has enhanced risk - sharing among participating member states and contributed to a smooth and effective implementation of monetary policy in the euro area. 13 to sum up, from a global perspective, the establishment of emu in january 1999 represents a fundamental institutional change in the world economy, and could in part help explain the large reallocation of capital that has taken place worldwide. a more sophisticated analysis based on an international portfolio choice model reaches the same conclusion ( see de santis and gerard, 2006 ). emu has enhanced regional financial integration in the euro area in both the equity and bond markets. there is evidence of active trading among euro area member states, with euro area investors assigning a higher weight to portfolio investment in euro area countries. over the period 1997 - 2001, the average increase in weights - on top of the world average portfolio weight increase in euro area assets - amounts to 12. 7 percentage points for equity holdings and 22. 4 percentage points for bond and note holdings. see ecb ( 2005 ). on international risk sharing and emu see for example sorensen and yosha ( 1998 ). the euro area – a zone of stability before concluding, let me emphasise that since 1999 we have experienced a number of important shocks to the global economy, such as the y2k problem at the turn of the millennium, substantial oil price increases, the fall and the rise of the euro exchange rate, the boom and burst of the equity market bubble, global imbalances and the clouds of war and terrorism. amidst

a flexible currency will be in a favorable position to use monetary policy to attain its internal growth and inflation objectives. when foreign interest rates increase and financial conditions tighten, changes in relative prices brought about by currency fluctuations can help to absorb the external shocks. the positive expenditure switching effect from currency depreciation improves the trade balance and supports demand. it is sufficiently larger than the negative investment demand effect from higher interest rates, such that internal balance is attained and monetary policy is able to pursue domestic inflation and growth objectives. 4 linda goldberg, paolo pesenti, joseph tracy and matthew higgins contributed to these remarks. a global financial cycle refers to the global co - movement of credit by banks and capital markets, asset prices, term premia, and risk premia. fleming ( 1962 ) and mundell ( 1963 ). krugman ( 1999 ). the balance sheet effects imparted from a large international debtor position may work against achievement of an improved external balance and attainment of internal balance. bis central bankers ’ speeches different policy options are available to a country with a high degree of capital mobility and a preference for currency stability. a country may prefer currency stability as an effective nominal anchor, or because of concerns about the broader uncertainties associated with currency volatility. regardless of the reason and because the exchange rate is not available to absorb external shocks, this country will be in an unfavorable position to achieve domestic macroeconomic objectives by using monetary policy. instead, monetary policy is aimed at external adjustment. tighter foreign monetary policy and financial conditions need to be validated by tighter domestic monetary policy to maintain currency stability. with domestic monetary conditions effectively imported from abroad, they may sometimes conflict with domestic growth and inflation objectives. simply put, currency stability is prioritized. these policy considerations are summarized in the well - known international policy trilemma. it says that a country cannot simultaneously maintain independent monetary policy focused on domestic objectives, a high degree of capital mobility, and currency stability. any two of these regime characteristics can be chosen, but not all three. while the trilemma suggests sharp tradeoffs, additional policy tools can soften the tradeoffs. fiscal policy is one tool that serves this purpose. when foreign credit conditions tighten, expansionary fiscal policy can allow a country with a high degree of capital mobility, and a policy preference for currency stability, to effectively manage towards domestic macroeconomic objectives and internal balance. in fact, fiscal policy can also be used to rebalance the composition