surprises in demand. and this helps to reduce the ups and downs of the business cycle and to promote sustained economic growth. the forward - looking framework of inflation targeting also allows us to handle temporary supply shocks, so long as these shocks do not feed into inflation expectations. the monetary credibility gained through our inflation - targeting system means that changes in volatile energy or food prices no longer feed into other prices and into wages the way they did in the past. that is why, unlike some other central banks, we focus on the underlying trend of inflation, and use as our operating guide a core rate that excludes the eight most volatile components of the consumer price index ( cpi ) and the effect of changes in indirect taxes on the remaining components. such a measure of core inflation is a better predictor of future inflation than the total cpi. with this approach, monetary policy responds only to fundamental trends and does not turn temporary price shocks into something that can destabilize the economy. how the bank of canada deals with international disturbances so far, i have described how our monetary policy framework, based on an inflation target, helps us respond to, and deal with, important surprises that have an impact on our economy. i would now like to say a few words about how the bank of canada incorporates external economic shocks into its decision - making process. canada is a small and very open economy. we export more than 40 per cent of what we produce and, in general, we are price - takers ( that is to say, the prices of what we buy and sell abroad are largely determined in world markets ). thus, the external environment is extraordinarily important to us. as part of its decision - making process, the bank has always followed world economic developments very closely. the bank's governing council starts its deliberations by looking at changes in the external environment. in particular, we focus on economic prospects for the united states and the major overseas countries, as well as on world commodity prices. then we look at the implications of all this for aggregate demand in canada. next, we focus on domestic demand, taking into account anecdotal information gathered by our regional offices, as well as trends in credit, money, and financial markets. all this feeds into our decision on interest rates. let me try and relate this to recent experience. take last year, for example. through the first half of 2001, we moved to loosen monetary policy at a measured pace. this approach was based on

and communications technology combined with regulatory and institutional changes have led to international capital markets and financial institutions becoming more closely interrelated than ever in the past. 5 growing financial integration among countries and regional areas is a potential source of benefits, notably due to enhanced opportunities for international risk sharing. indeed, financial globalisation may provide countries with instruments to hedge against idiosyncratic shocks in order to better smooth consumption smoothing, thereby yielding significant welfare gains. in addition, larger integration into the international financial system may contribute to the efficient functioning of the entire economy by providing additional financing at a reasonable cost to domestic agents, by facilitating the transfer of technology from abroad and by stimulating the performance of the domestic financial sector. however, financial globalisation may also entail some risks. increased international financial integration is likely to lead to a larger sensitivity to external spillovers. under more extreme circumstances, the experience of some developing countries suggests that increased integration into international financial system, if not accompanied by the establishment of high - quality institutional and regulatory frameworks as well as sound macroeconomic policies, may make countries more vulnerable to episodes of financial and macroeconomic instability. see gonzalez - paramo, j. m. ( 2007 ) “ globalisation and monetary policy ”, lecture at suomen pankki, helsinski, 15 march ( http : / / www. ecb. europa. eu / press / key / date / 2007 / html / sp070316. en. html ). fisher, r. w. ( 2005 ). " globalization and monetary policy ", warren and anita manshel lecture in american foreign policy, harvard university, 3 november. see for instance stanley fischer ’ s analysis in bis ( 2006 ), cit. 3. the financial turmoil the episode of financial market turmoil that we have experienced since august 2007 provides a good illustration of how, in a globalised economy, an idiosyncratic shock can be propagated more rapidly and through a variety of new channels to seemingly distant countries and markets. indeed, the turmoil originated in a relatively small segment of the us economy – the sub - prime segment of the mortgage market – that has no obvious relationship with the eurosystem ’ s sphere of interest. yet, its quick propagation caused an increase in volatility and a decline in liquidity in a variety of markets all around the world, including the euro area market for inter - bank unsecured loans that represents a key component of the money market and the starting point of