the stability of the financial system as a whole, and improve the financial sector ’ s ability to serve as a source for sustainable growth for the broader economy ” this enhanced financial stability is a significant contribution of basel ii to monetary policy. in general terms, a better functioning of the banking system will tend to improve the efficiency of the monetary policy transmission mechanisms. in addition, one could think of a positive effect on the expectations about better financial stability. second, basel ii is about much more than just setting better quantitative minimum capital requirements. it is about establishing an incentive - based approach to risk management and capital adequacy, within a framework of the three mutually - supporting pillars the new comprehensive framework provides at least four transmission channels for influencing financial stability and the overall economy : first, by setting more risk - sensitive minimum regulatory capital requirements, so that regulatory capital is both adequate and closer to economic capital ; second, by providing incentives to encourage improvements in banks ’ internal risk management processes ; third, the enhanced mechanisms to encourage the marketplace to exert external discipline on banks and the banking sector ; and fourth, the necessary greater co - operation among supervisors across jurisdictions. the effects of each of these channels will be different in terms of time and in terms of final influence, some of them having the capacity to bring significant long - term positive changes to the financial markets. in my view, perhaps too much attention is placed on the minimum capital rules of pillar 1 and not enough on the effects of the other three channels. 3. implications of basel ii for monetary policy let me therefore turn to the issue of how the main elements of basel ii may affect the ability of the monetary authority to fulfil its objectives. i believe that the achievement of price stability as a desirable medium to long - term target is, by now, a non - controversial objective of primary importance whose foundations are well known. on one hand, the proposition that labels inflation largely as a pure monetary phenomenon within long time - horizons can hardly be contested either conceptually or empirically. furthermore, a wide consensus among academics and policymakers has emerged over recent decades on the damaging effects of high inflation levels and variability on economic growth and, hence, on social welfare. indeed, the history of monetary policy in the last 20 years or so is a very successful one. price stability, as it is usually defined, is currently a tangible reality in most developed countries. also, many less - developed countries previously prone to endemic high inflation have managed to reduce and stab

contrast between this optimism on financial markets and the wariness of companies, mirrored by slack investment in the real sector which is particularly striking if regard is had to the favourable trend of corporate profits. several explanations have been offered for the muted performance of business investment in recent years, such as the difficulties in valuing investment in intangible assets appropriately, over - investment in the second half of the nineties ( which caused surplus capacity in recent years ), the ongoing reduction in corporations'financial leverage, the uncertainty generated by globalisation and companies'caution following the recent changes in the legislative and accounting framework in the wake of the corporate scandals in some countries. insofar as some of these factors are probably transitory, greater investment momentum may be expected in the coming years. the buoyant global demand for commodities and the attendant rise in their prices were conducive to the economic growth of the commodities - exporting countries, while widening the room for manoeuvre of their economic policies. the latin american countries benefited from this positive effect on their terms of trade, enabling them to reconcile relatively high growth rates with current - account surpluses. in this respect, a clearly contrasting use was made of this greater flexibility by the latin american countries : while some have sought to strengthen their macroeconomic fundamentals and reduce their vulnerability by limiting and improving the terms of their debt, others have given an interventionist bias to their policies which seriously undermines the maintenance of legal security and dents their mediumterm investment and growth prospects. as stated, an essential ingredient in the stability of the world economy has been the maintenance of moderate inflation, despite the rise in energy and other commodities prices. admittedly, the dynamism of china and other emerging asian economies has contributed to this increase in commodities prices ; but their penetration in the international markets for manufactures has also helped contain wage and price pressures. the greater anti - inflationary credibility of monetary policies is, in any event, responsible for anchoring inflation expectations at moderate levels, having prevented the so - called " second - round effects " – via prices and wages – that prompted a global inflationary spiral in the eighties in the wake of dearer energy. this diagnosis, far from making us complacent, should be a reminder that such credibility cannot be taken for granted ; rather, it has been attained thanks to policies clearly geared to safeguarding price stability, policies which we are bound as central banks to persevere with. what does the immediate