a financial crisis. a lowering of the policy interest rate would - under such conditions - provide no stimulus to the economy. second, as one of the classical functions of a central bank is to extend emergency liquidity assistance, central banks need adequate information not only on financial markets in general but also on individual institutions. as monetary stability might be affected when a big player gets into difficulties, central banks should be in a position to form a view if a certain institution is illiquid or insolvent, and if the latter is the case, whether this institution is of systemic importance or not. an additional challenge here is that institutions outside the supervisory umbrella - such as hedge funds - tend to grow significantly. moreover, the growth of financial markets in general and the growing importance of financial conglomerates in particular go hand in hand with a greater opaqueness of the size and distribution of risks. this puts additional demands on the analytical capacity of those concerned with financial stability. third, with financial liberalization, asset price and credit cycles may have become more prominent and suggestions have been made that monetary authorities should react to this cycle, for instance by raising interest rates when stock markets are clearly overvalued. central banks may thus have an interest to contribute to the discussion of prudential rules, which could contribute to a dampening of the asset cycle. prudential rules, and not interest rate changes, are there to safeguard financial stability. this is not to deny a role for asset prices in the monetary policy strategy. in the context of the ecb ’ s monetary strategy they are monitored to draw conclusions about future price developments, but there is no reaction to movements on financial markets as such. as the priorities within the eurosystem are clear there is no risk that the central bank loses sight of its primary goal of price stability for fear of a negative reaction of the stock market. ladies and gentlemen, to shield the real economy as far as possible from financial instability and prevent instability in the first place, continued adaptation of public policy to the changing financial landscape is required. to keep monetary policy effective, a smooth functioning of a diversified financial system is also in the interest of central banks. monetary policy can contribute to financial stability by keeping expectations about future inflation as low as possible and thus reducing inflation risk premia to a minimum. even when monetary policy cannot eliminate excessive risk - taking and speculation it can at least try to avoid fueling it. let me conclude by saying that we must never lose sight of why we

the international financial system would be wasted if they cannot build on the preparedness of any country in the world to keep its own house in order. if this effort is pursued collectively, for example on a regional level, a higher leverage can be achieved. monetary and fiscal discipline in the euro area and structural reforms making the economy more flexible will both make the euro area less prone to originate shocks but also less vulnerable to outside shocks. the third avenue public policy should take is to give more attention to the legal infrastructure of financial markets, covering both bankruptcy procedures and effective corporate governance. this could also be a standard feature of international surveillance. “ ordnungspolitik ” thus has to get prominence in the design of worldwide integration and liberalization strategies. the liberalization of capital movements, as desirable as it is, must go hand in hand with the establishment of sound and efficiently supervised financial systems ; otherwise not only the countries which liberalize prematurely would suffer from a potential sudden reversal of capital flows and the ensuing exchange rate and economic crisis, but also the world economy as a whole would be hit. let me just mention that - due to the asian and russian crises - some regions of the euro area will experience substantially lower growth this year than last year, and for the same reasons real growth in the euro area as a whole dropped from around 3 % in 1998 to an estimated 2. 1 % this year. to sum up, public policy in general and financial supervision in particular thus have an important role to play. they have to keep the long - term stability and health of the financial system in mind, correcting for the - very often - rather short - term orientation of financial markets. public policies should be designed to avoid the headache after the party, by moderating exuberance and exaggeration. this is certainly more easily said than done and probably not always popular. but are watchdogs there to be popular? 5. let me now turn to the question of why financial stability issues are of concern to central banks. first, central banks must nowadays even more than in the past know what is going on in financial markets. they need to be in a position to assess how the transmission mechanism is influenced by changing financial market conditions. moreover, monetary policy must have an interest in the smooth functioning of the financial system. as the japanese example shows, monetary policy may become ineffective when there is a liquidity trap or when bank lending is restrained by the need to rebuild capital in the aftermath of