in the overnight money market. this need for adjustment also explains why at the bank we are sticking firmly to the plan to allow the special liquidity scheme to run - off on time a year from now. over the last twelve months, banks have taken the necessary steps to move towards that goal. it is all about getting the banking system into a position where it can demonstrate robust capital and liquidity buffers, and to do so by facing up to the discipline of the market rather than the support of the authorities. the edinburgh fund managers are an important part of that market discipline. in a market economy, you are in the front line of defence and discipline. now, i cannot say that the uk is insulated from the risks we observe in other parts of europe. as our most recent financial stability report, published just before christmas, made clear, “ the united kingdom is only partially insulated given the interconnectedness of european financial systems and the importance of their stability to global capital markets ”. as the report also made clear, there are other, probably more medium - term risks posed by evidence of low bond yields in many advanced countries and signs of an intensifying search for yield as capital flows into alternative assets, including into emerging markets. against this backdrop of risks, it is in the collective interest of banks to continue to build up progressively their capital and liquidity resilience so that they support not only themselves, but also the stability of the financial system as a whole. the basel iii agreement, and the reform programme of the g20 and the financial stability board set up under the g20, will provide the supporting framework by which the authorities will back up the discipline of the market to achieve and maintain financial stability. this brings me back to the reforms in the uk. at their heart lies the objective of putting the stability of the financial system at the centre of the regulatory mission. you may say, “ surely that ’ s not new ”. i would disagree – our overriding objective must be to create a consensus of public opinion which will enable financial stability to be embedded as a public policy objective in the same way that in the wake of the 1970s, low inflation came to be adopted as a necessary condition for stable economic growth. too often, i hear people say that achieving financial stability needs somehow to reflect a balance with other objectives, such as competition, consumer protection, and the like. i ’ m sorry, but while these objectives are of course very important, the best way

low inflation. indeed, there is now some evidence, in canada and in other low - inflation countries, of an increase in the relative importance of variable pay schemes ( bonuses, etc. ) as opposed to increases in base wage rates. 23 if sustained, this development would help to increase wage flexibility. as i have said in the past, i have a great deal of difficulty with the idea that wage earners in canada are subject to a permanent money illusion that can, and should, be exploited by the monetary authority. 24 how can monetary policy be eased when inflation is very low and interest rates are close to zero? one of the criticisms of the goal of price stability, or a very low inflation rate, is that it rules out using negative real interest rates ( i. e. interest rates lower than the rate of inflation ) to provide stimulus to the economy should this become necessary. this line of argument implies that one should avoid targeting a very low rate of inflation because of the added flexibility that the possibility of having negative real interest rates gives to policy - makers at a time of economic weakness. see fortin ( 1996 ) and akerlof et al. ( 1996 ). see crawford and harrison ( 1997 ). crawford and harrison ( 1997 ). see thiessen ( 1996 - 97 ). - 11 - in assessing this criticism, it is important to remember that the achievement of price stability is likely to lead to a lessening in the amplitude of business cycle fluctuations. in the post - war period, deep recessions ( of the sort that might, in extreme cases, call for negative real rates ) have typically been preceded by periods of strong inflation pressures. these pressures resulted in significant economic distortions, which, in turn, affected the depth of the subsequent downturn. in the absence of such inflationary distortions, the downturns are likely to be much milder. hence, there is less likelihood that a period of negative real interest rates would ever be called for. moreover, while nominal short - term interest rates cannot be less than zero, it is worth underlining that a near - zero nominal rate will still imply a real interest rate that is appreciably below its equilibrium value and will provide considerable stimulus to the economy. finally, in a small open economy with a flexible exchange rate regime, monetary conditions can become easier as a result of both interest rate and exchange rate movements. even if there were only limited easing possible via the interest rate, there could still