i would welcome the chance to demonstrate how the process is meant to work. the opportunity to write to the chancellor did not arise last week. but since we are so close to the level that would trigger a letter, let me instead write a letter to you. over the past year cpi inflation has risen by a percentage point, from around 2 % to 3 %. that was not the committee ’ s expectation a year ago when it believed the most likely outcome was for inflation to stay around 2 %. and at that point many commentators were predicting cuts in interest rates in 2006. so what happened? part of the story has been a further sharp rise in energy prices during 2006. but it is only a part. it is impossible to be sure what explains the rest of this unexpected drift up in inflation. but three factors seem to be relevant. first, the historically low level of interest rates and rapid growth of money and credit have contributed to rising asset prices and buoyant nominal spending, not just in the uk but around the industrialised world. spending and capacity pressures in the uk economy recovered from the slowdown in 2005 faster than many had expected. second, and a direct consequence of the first, is that inflation expectations have risen. firms have been able to raise prices a little faster than before with the expectation that now those increases would stick. as the birmingham chamber ’ s own recent quarterly survey showed – “ over half of the city ’ s manufacturers were intending to increase prices in the next three months ”. one of the reasons for the success of inflation targeting is the anchor which it gives to inflation expectations. but, when inflation moves away from target, we must prevent the anchor from dragging. expectations need to be firmly fixed on the 2 % target. third, increasing cost pressures have made it more difficult to sustain profit margins without raising prices. energy and import prices are one source of higher costs. another is the cost of employing labour which has been rising faster than the growth of real take - home pay. higher pension costs for companies, on the one hand, and higher taxes, petrol and utility prices for employees, on the other, have opened up a gap between increases in the pay bill and real take - home pay. if investment and employment growth are to be maintained, the burden of these higher costs must either be passed back in the form of reduced input costs or forward as higher prices. so far, pay pressures have been subdued, but not sufficiently so to mitigate the rise in costs

imbalances. but even the best rules only work if they are respected. and even the best rules may not prevent a country from experiencing economic shocks.... but union also means community for cases where these shocks are too big to be absorbed at national level, a monetary union needs mechanisms to spread the ensuing costs over more than one pair of shoulders. and this brings me to the second question : how can risks be shared at european level without a transfer of risk occurring which distorts the incentives for the individual member states? i mentioned this earlier : during the crisis, risks were shared especially by way of mutual guarantees and thus via national budgets. however, such a sharing of fiscal risks can reduce the incentives to pursue sound fiscal policies. in order to counter this disincentive, both the risks and the monitoring would therefore have to be shared at european level. so the presidents of the european institutions 3 – including the ecb – are calling for stronger fiscal integration leading to a fiscal union. for the moment, i see little political will to create a european fiscal union. fiscal risk - sharing, for the time being, therefore remains a problematic issue. as long as the basic willingness to share fiscal sovereignty is lacking, we could and should then agree that sovereignty will be relinquished if a member state does not comply with the jointly agreed objectives, such as the deficit and debt limits. at the same time, it ’ s necessary to strengthen national ownership and private risk - sharing. from an economic perspective, it would seem obvious : if a state gets into financial difficulty, why shouldn ’ t the state ’ s creditors bear the losses? in reality however, this is not so easy to implement. bear in mind how long it took to arrange that for the resolution of banks their creditors will also be liable in the future. where does the problem lie? it lies in the possible contagion effects and in concerns about financial stability. the creditors of countries are in many cases the domestic banks. a state bankruptcy with a bail - in could therefore trigger a financial crisis. masuch, k. ; moshammer, e. ; pierluigi, beatrice ( 2016 ), institutions and growth in europe. centre for european policy studies ( ceps working document no. 421 ). “ completing europe ’ s economic and monetary union ”, presented by j. - c. juncker, in close cooperation with d. tusk, j. dijsselbloem, m. drag