to moderate in the coming quarters, wage and price - setting behaviour is characterised by considerable inertia. it is also possible that domestic cost pressures may turn out to be stronger than expected – a prospect that is supported by recent developments in wage and unit labour cost growth. 2 for all these reasons, our current assessment is that the risk of deflation in the euro area remains remote despite the expected weakness in economic activity this year. the prospects for economic growth the latest data and survey indicators point to a substantial decline of real gdp in the fourth quarter of 2008 and to a continued weakness in economic activity in the euro area in the first half of this year. confidence is at historically low levels, world trade has sharply declined and financing conditions remain tight. all these factors are adversely affecting aggregate demand. recently, some survey indicators showed signs of stabilisation. it is too early to declare that we may be reaching the bottom of the downturn on the basis of these signals. other indicators point to a less encouraging, if not gloomier, outlook. in other words, what we see flashing amid the clouds that cover the economic landscape right now could either be a silver lining and a first ray of light, or the harbinger of stormier weather conditions. the risks to economic growth remain on the downside. among the factors that may adversely affect economic activity is the prospect of growing protectionism. economic nationalism is an emerging threat to global economic recovery and should be avoided. another risk is the possibility that the financial crisis may have a greater negative impact on the real economy than currently expected. this could be the outcome of the mutually reinforcing effects of weak economic activity, deteriorating bank asset quality and constraints on the supply of bank credit. the intensification and broadening of the financial market turmoil since september has significantly affected the pace of broad money growth and the expansion of bank credit to the private sector. the flow of bank loans to the private sector has decelerated steadily in recent months, and in december it turned negative for the first time since the outbreak of the financial turbulence. at the same time, there are some positive developments. the substantial reduction in ecb interest rates since last october is being passed through to lower bank lending rates, thus easing financing conditions for companies and households. i also find it encouraging that money market conditions have improved gradually but steadily. money market spreads have progressively narrowed, even though they remain at elevated levels and the turnover in unsecured money market remains rather

- makers around the world are assessing whether – and to what extent – certain features of the financial system encouraged market excesses and the build - up of large financial imbalances. and they are considering what changes should be made to the financial system and to the regulatory and supervisory framework to reduce the pro - cyclical behaviour of financial markets. in my view, the past two years have demonstrated a number of weaknesses of the financial system. it is imperative for policy - makers – and market participants – to address these weaknesses so as to avoid the recurrence of similar excesses and imbalances in the future. for us as central bankers, it is essential for an additional reason : even if tackling the structural weaknesses is a task for the longer term, we need to start now in order to contribute to the restoration of confidence also in the short term. the markets need to see that serious and concerted efforts are undertaken to safeguard financial stability in a sustained manner. several important activities are underway in this respect. at the global level, under the aegis of the g - 20 and the financial stability forum, and in europe, on the basis of the ecofin council ’ s roadmaps. the various measures being discussed and agreed in these fora aim at addressing the inherent procyclicality of the financial system. the focus of the work is on : ( i ) regulatory aspects, and notably capital requirements ; ( ii ) fair - value accounting and provisioning regimes ; ( iii ) incentive schemes ; and ( iv ) transparency and disclosure rules. moreover, steps are being taken to strengthen the regulatory and supervisory framework in europe in order to enhance both crisis prevention and crisis management. there is no time on this occasion to go into details on all of these issues, but let me comment on three : ( 1 ) accounting standards ; ( 2 ) capital requirements – and the complex interrelation between the two – and ( 3 ) the need to strengthen the macroprudential supervision of financial markets and institutions. let me start with accounting standards. finance and accounting have close and powerful links. the current fair - value accounting rules have been identified as having contributed to financial market dynamics. the “ self - reinforcing downward spiral of higher haircuts, forced sales, lower prices, higher volatility and still lower prices ” 5 has become an all too frequent phenomenon in financial markets. when markets are dysfunctional or illiquid, i have doubts whether marking - to - market