##rio aptly put it in 2008, has, in the end, “ distributed fear rather than risks ”. however, while financial innovation has undoubtedly increased vulnerabilities in the global financial system, there is more to the present financial market turmoil than meets the eye of the casual observer. the proliferation of structured finance products and the “ originate and distribute ” model would arguably not have been possible without the benign economic and financial backdrop notably robust global economic growth, low inflation, a low level of interest rates, low default rates and rising asset prices in many countries, not just in the usa. this goldilocks economy, where conditions were neither “ too cold ” nor “ too hot ”, had – as a side effect – masked the gradual build - up of financial imbalances. hence, while lending and risk - taking experienced rapid growth, words of warning by central banks and other institutions were largely disregarded on the basis of “ this time, developments are surely different from the past ”. the fact that minor financial market tensions in the spring of 2005 and in 2006 had left financial markets more or less unscathed only reinforced that impression. once, however, the vulnerabilities in the global financial system were revealed in august last year and financial imbalances started unwinding, we all witnessed that the scene changed considerably. financial stability analysis at central banks for some time now, there has been much talk about financial stability and the respective role of central banks, and so i would like to address this topic here. a widely accepted definition of financial stability is the ability of the financial system to perform its key functions efficiently – namely, the allocation of capital and risks and the settlement of payments and securities transactions. these functions must be fulfilled smoothly not only in normal times but also during periods of structural adjustment and stress. stable financial systems reduce uncertainty and therefore develop positive external effects on the real economy, thereby contributing to greater economic prosperity. however, the reverse is also true : instability in the financial system can have negative external effects and therefore cause high economic costs. contributing to financial stability is thus part of a central bank ’ s core area of responsibility, in order to ensure price stability and avert negative repercussions of the financial system on the real economy. just over a year ago, some observers questioned this view, calling it a temporary “ fad ” or even dismissing it as the result of central banks ’ searching for new responsibilities – these voices have now been silenced for obvious reasons.

therefore not yielded to calls to relax our monetary policy stance. if we did, monetary policy would only strengthen the shock - related inflationary pressures. at the current juncture, however, with inflation in the euro area having reached a record high and inflation risks still on the upside, there is the concrete risk that longer - term inflation expectations will start creeping up more strongly. the experience of the great inflation demonstrates that a stability - oriented central bank is well - advised to fight the risk of broad - based second - round effects decisively and proactively. by doing so, it will keep the costs of curbing inflation dynamics relatively low. our commitment to a systematic focus on price stability is even more important, as the recent rounds of wage settlement in the euro area have not contributed to curbing inflation pressures. on the contrary, recent wage dynamics in conjunction with elevated and persistent energy and food price pressures have increased the risk of a prolonged period of intolerably high inflation. at our last meeting of the ecb governing council, we emphasised that, given the uncertainty about the economic outlook and the prevailing downside risks to economic growth, the continued vigorous expansion of money and credit and the strong upside risks to price stability, the governing council is in a state of heightened alertness. financial markets should by now have understood our readiness to act. it is our strong determination to secure a firm anchoring of medium and long - term inflation expectations in line with price stability. after all, the best contribution that the eurosystem can make to sustainable growth in the euro area is to safeguard price stability in the medium to long term and lastly we should also not forget that a reliable monetary policy also helps to reduce uncertainty in times of an ongoing financial market turmoil. thank you for your attention. references beyer a., v. gaspar, c. gerberding and o. issing : “ opting out of the great inflation : german monetary policy after the breakdown of bretton woods ”, paper prepared for the nber conference “ a retrospective on the great inflation ”, organised by michael bordo and athanasios orphanides, woodstock, september 2008. borio, c. ( 2008 ), “ the financial turmoil of 2007 -? : a preliminary assessment and some policy considerations ”, bis working paper no 251, march 2008. clarida, r., j. gali and m. gertler ( 2000 ) : monetary policy rules and macroeconomic stability : evidence