jean - claude trichet : making decisions in an uncertain world speech by mr jean - claude trichet, president of the european central bank, at the rheinisch - westfalische technische hochschule ( rwth ), aachen, 1 june 2011. * i. * * introduction it is a pleasure for me to be here in aachen, a city that has played such a central role in the project of european integration. as students at rwth aachen, you must be proud to be part of one of europe ’ s leading institutions for science and research. this university has an international reputation, demonstrated both by its participation in global networks of higher education and by the presence of a large contingent of students from around the world. a degree from such a renowned university is indeed a great asset and a remarkable insurance against the uncertainties of your working lives. in pursuing your studies, you have already had to make important decisions under uncertainty. your choices of university and degree course were made with limited information – about the chances of obtaining the degree, about the impact of your degree on future job opportunities and about its relative merits compared with alternatives. such uncertainty is a constant feature of our lives, as we experience the structural transformation of our economies driven by new technologies and globalisation. fifty years ago, future career paths were clear for most graduates. engineering students would become engineers and medical students would become doctors. nowadays all professions change at much greater speed. engineers and doctors work side - by - side in such areas as nanotechnology and biomedical engineering. many of you will be not so much filling existing jobs as inventing whole new jobs. at the same time, increasing interactions between people and organisations across geographical borders makes it more difficult to appreciate the potential impact of economic developments elsewhere in the world on the prospects for your home country. the process of globalisation has many positive consequences, such as the benefits of trade, financial market integration and the acceleration of global growth. but there are risks too, such as the accumulation of so - called “ global imbalances ”, which were a key underlying cause of the global crisis. all of you will be aware of the difficulties that the world economy has experienced in recent years : the financial crisis that began in 2007 and led to the deepest recession since world war ii. devising appropriate policy responses to the crisis has been a challenge for central banks everywhere. many decisions have had to be made under exceptionally uncertain conditions, sometimes with very limited information and

better policy can take some credit for this improvement, as the anchoring of inflation expectations led to a huge reduction in inflation volatility. it was tempting to think that we had moved onto the “ taylor frontier ” – which maps feasible combinations of the smallest variances of the output gap and inflation. the great stability appeared to be a permanent break from earlier periods – periods when monetary policy exhibited more unpredictable behaviour and left the economy to the north - east of the taylor frontier ( chart 2 ). and in one important sense it was – the dark days of double - digit inflation were consigned to the past. the inflation measure used is the quarterly rate of increase of the gdp deflator, defined as the ratio of nominal gdp to real gdp. the output gap is estimated as the difference between the log of real gdp and the trend path of log gdp, derived using the hp - filter. source : ons and bank of england calculations. bis central bankers ’ speeches but the great stability was not representative of a new normal. the variance of the output gap – though not inflation – has been much higher over the past five years as the financial crisis generated a deep recession ( chart 3 ). so what have we learned? the banking and broader economic crisis has demonstrated that macroeconomic policy can face an additional trade - off between ensuring the soundness of the financial system in the medium term, and keeping output in line with potential output and inflation on target in the near term. such a trade - off arises because financial vulnerabilities can build even while output is growing steadily and inflation is low and stable. let me give three examples of the sort of underlying mechanisms at play. first, persistent misperceptions of future spending power may generate a mix of demand that proves to be unsustainable. i believe this was an important factor underlying the crisis. although output in deficit countries – like the uk – appeared to be growing at a sustainable rate, that gave a misleading impression of the sustainability of the great stability. in fact the level of domestic demand was too high and the level of net exports correspondingly too weak. second, as hyman minsky described, periods of stability encourage exuberance in credit markets, leading eventually to instability. and third, low short - term policy rates may encourage investors to take on more risk than they would otherwise accept as they “ search for yield ”. it is arguable that monetary policy paid insufficient heed to the potential impact of such