##ulatory impact on output and employment than it would have without changing exchange rates. in this exchange regime it makes sense for a country to rely on monetary policy as its primary stabilization tool and let fiscal policy influence the nation ’ s overall saving rate. it might seem like this assignment of responsibilities would consign fiscal policy to oblivion, but in fact not so. in the long run the most important policy a country has to influence its long run living standards is fiscal policy, operating through just this influence on national saving. interestingly, these conclusions are totally inverted if a country is following a fixed exchange rate policy, which means that its central bank intervenes in markets to set the value of its currency. a great variety of exchange arrangements fall into this category — a gold standard, a currency board, dollarization, and exchange rate zones would all be considered as fixed exchange rate regimes for these purposes. in these cases, central bank policy ( if indeed there is a domestic central bank at all ) must be dedicated to setting the exchange rate and cannot be used to stabilize output and employment. ∗ mr gramlich presented an identical speech at the jerome levy economics institute, bard college, annandale - on - the - hudson, new york on 23 april 1999. interest rates cannot deviate from the level necessary to determine the pre - set exchange rate. fiscal policy becomes the pre - eminent stabilization tool by necessity. as expansionary fiscal policy threatens to raise interest rates and drive up the exchange rate, the process induces a rise in the money supply to preserve the fixed interest and exchange rates, accommodating a larger rise in output than would be the case in a closed economy. for this reason the impact of fiscal policy on the economy is even greater than it would be in a closed economy. timing issues since stabilization policy is dedicated to mitigating business cycles that can be of relatively short duration, timing also matters in developing a stabilization strategy. fiscal policy contains automatic stabilizers — basically tax revenues that rise in booms and fall in recessions, hence stabilizing overall spending demands. these stabilizers cut the amplitude of cycles in output and employment, but they do not eliminate the cycles. to eliminate cycles altogether, policymakers must act in time for their policies to offset incipient booms or recessions. the average postwar recession in the united states has been slightly less than a year long, which narrows the time horizon for what are known as discretionary policies considerably. two types of la

, although uk banks ’ exposures to governments, households and businesses in the affected countries are generally manageable, they do have exposures to, and get finance from, euro - area banks which are more heavily exposed. a disorderly outcome in the euro area could then result in a tightening of the availability of funds to uk banks as a result of this interconnectedness and thus also in the credit extended to uk households and businesses. third, a bad outcome would probably knock confidence and lead uk households and businesses to hunker down and postpone spending. there is little that the monetary policy committee – or, indeed, the government – can do to influence the outcome of events beyond our shores. in particular, it would make little sense to set the level of asset purchases so as to try to counteract an extreme event whose likelihood, timing and magnitude we have no realistic way of assessing. the latest extension of our asset purchase programme has proved controversial in some quarters. some commentators have questioned its likely effectiveness in stimulating demand. others have focussed on the undesirable distributional consequences. as far as the effectiveness of the policy goes, the impact depends on what those who have sold the gilts do with the money we give them in return, and how banks, businesses and households respond to the resulting movements in asset prices and money holdings. it is quite possible that the impact of a given quantum of purchases will be different at different times and be sensitive to the prevailing economic conditions. but that is also the case with changes in bank rate, where the effects can be equally uncertain. bis central bankers ’ speeches tracking the impact of the new round of purchases is also harder than before. market participants have increasingly come to anticipate our actions, so that asset prices tend to move ahead of our decisions. that makes it difficult to isolate the impact on asset prices of policy changes from the myriad of other things driving them. the fact that uk government bond yields have fallen about a quarter percentage point more than those in germany and the united states since the late summer is, however, at least consistent with the effect we expected. in any case, so far we have seen little to suggest that the effect on nominal demand will be markedly at odds with that of our first round of purchases. but it is still rather early to draw firm conclusions one way or the other. turning to the distributional consequences of the asset purchases, attention has focussed on the downward impact on annuity rates, which have fallen