the canadian economy and the outlook. first, a bit of history. following the 11 september 2001 terrorist attacks in the united states, the bank of canada, like other major central banks, moved quickly and aggressively to cut its policy interest rate to shore up confidence. that dramatic monetary policy action helped a great deal. by the spring of 2002, it became evident that our economy hadn't been knocked off track by the events of 11 september. indeed, evidence was starting to build that the economy was growing faster than its production potential, taking up the remaining small amount of economic slack. so, we raised our key policy rate three times between april and july, by a total of three - quarters of a percentage point. but by late last summer, we were seeing the effects of financial headwinds, geopolitical uncertainties, and continued weakness in the global economy. these factors remained in play through the autumn. as a result, we refrained from raising interest rates, even though inflation was accelerating. our initial analysis was that this increase in inflation would be temporary. however, both core and total cpi inflation remain well above target. this reflects the impact of higher - than - expected prices for crude oil and natural gas, continuing increases in auto insurance premiums, and price pressures in certain sectors, such as housing, food, and some services. the higher inflation also suggests an underlying firmness in the price - setting environment. in other words, relative price increases wouldn't be pushing up trend inflation if there was not sufficient demand. indeed, final domestic demand - especially household spending - has remained robust. however, economic growth in canada moderated in the final three months of 2002, largely because of weaker exports - most notably, a decline in automotive shipments to the united states. even with this slowing growth in the fourth quarter, upward revisions for previous quarters leave the level of economic activity slightly higher than we had been monitoring. in fact, canada's economy remains near full capacity. let me list some of the indicators that support this view : high industrial capacity utilization ; near record - high labour force participation rates ; a record - high employment - to - population ratio ; corporate profits at their highest level since early 2001 ; and, as i said a few moments ago, above - target trend inflation. while we continue to foresee growth somewhat below potential in the first half of this year, we expect increased demand in the second half of 2003 and into 2004, as global uncertainties diminish

second, the imposition of such an additional capital requirement may also inhibit the expansion of banks ’ balance sheets, so dampening the upswing of the credit cycle. this second mechanism obviously requires the modigliani - miller theorem to fail, in the short run at least ; if it doesn ’ t then there is no reason for a bank ’ s management to prefer debt finance to equity finance. now the most obvious reason why the modigliani - miller theorem fails for banks is the implicit subsidy to debt finance that comes from being “ too big ( or too complex ) to fail ” so that taxpayers, rather than creditors, pick up the tab if capital is insufficient to absorb losses. recent and prospective regulatory reforms seek to reduce the too big / too complex to fail problem, but eliminating it entirely may be an aspiration too far. moreover, there are likely to be other frictions to raising capital which mean that raising capital requirements will inhibit balance sheet growth, providing traction for the countercyclical capital buffer. however, this is an area where empirical evidence is in relatively short supply ( though for some examples, see : macroeconomic assessment group, 2010 ; and aiyar et al., 2012 ). the second tool is the ability to vary capital requirements by type of asset, allowing the fpc to target excessive exuberance in specific sectors. the eu will permit national authorities such discretion in regard to residential property, commercial property and intra - financial sector exposures. while this list is clearly not exhaustive, it does include some of the main sectors that have historically been most subject to over - exuberant credit growth. the final tool is the ability to set and vary a minimum leverage ratio. a leverage ratio is essentially just ( a transformation of ) the ratio of capital to unweighted assets. such a measure fails to allow for the varying riskiness of different forms of lending. however, the wide variation in risk weights across banks raises questions about the reliability of those risk - weight models. moreover, as my colleague andy haldane ( haldane and madouros, 2012 ) recently documented, a simple leverage ratio measure does a somewhat better job of predicting which banks were more likely to get into difficulties during the crisis than does a bis central bankers ’ speeches risk - weighted capital ratio 2 ( see chart 2 ). given the imperfections of risk - weighting, the ability to impose a minimum leverage ratio provides a useful additional instrument that can backstop the usual