in the monetary policy arena. in line with many central banks, we have a mandate in statute – the bank of england act – to conduct monetary policy. the government sets a target inflation level which we are required to meet. importantly we – and you – can see how we are performing month by month in relation to our mandate. we also have a tested analytical framework. we model possible future outcomes and we look at the balance of risks around a central view. we can rely on experience and judgement to make regular policy decisions. and we can alter our policy decision on interest rates each month as the data and circumstances evolve. ii ) financial stability and why it is different if financial instability occurs, costs to society may be high. damage to our reputation could be potentially high too. yet judging the optimal amount of resources to devote to prevent crises is problematic. what degree of resilience do we want? and what should we be prepared to pay for insurance? this is a familiar problem in public policy – what is the optimal size of the fire brigade or army? the challenges we face in seeking to maintain financial stability are very different to those in the monetary policy arena. • firstly there is neither a clear over - arching analytical framework nor a commonly agreed set of indicators of incipient financial instabilities. • secondly the task is made harder because we are dealing with tail events – low probability scenarios – rather than central projections. it is about aberrant rather than normal behaviour and situations : less predictable and harder to model. • thirdly there are a number of different potential policy instruments that can affect the financial environment in various, sometimes conflicting, ways. and by no means are all in the hands of central banks • fourthly national financial stability responsibilities are often shared. in the uk we work with her majesty ’ s treasury ( hmt ) and the financial services authority ( fsa ). for cross - border activities we operate alongside overseas central banks and supervisors. • fifthly although the roles of the uk authorities are outlined and published in a memorandum of understanding ( mou ), this gives little guidance as to what financial stability is or a clearly identifiable target. • and lastly it is harder to get motivational feedback – unless in unwelcome form should a crisis occur. 3. defining our role in financial stability oversight these factors pose a number of challenges in defining our role in financial stability oversight – what activities should we as a central bank undertake? to make these decisions, firstly we should

the euro area was more modest, with the policy interest rate falling from 4. 75 % to 2 % over the same period. since mid - 2004 the fed has raised its policy rate by a cumulative 375 basis points, while the ecb started to raise rates only in late 2005 and since then has increased them by 50 basis points. against this background, i would like to address the following questions : how can these differences in the pattern of policy rates in the two currency areas be explained? do they reflect differences in the monetary policy strategies adopted by the two central banks or deeper differences in the structure and dynamism of the two economies? the observation that the policy rate has been much less volatile in the euro area than in the us can certainly not provide reliable information on the strategy of the two central banks, nor can it prove that the monetary policy of the ecb has been too gradual, or not sufficiently active. to answer these questions, it is crucial to assess policy moves against the prevailing state and structure of the respective economy. some early research undertaken by ecb watchers already addressed this topic. 1 some more recent work undertaken by ecb staff has provided further insights that i believe are worth discussing today. the common theme of this work is that the causes of the different behaviour of policy rates in the euro area and the us over the last years can mainly be found in the following two factors. first, shocks of a different nature and pattern have hit the two economies, generating an unfavourable trade - off between inflation and output in the euro area, while the us economy was supported by rather strong productivity improvements. second, the structure of the two economies is very different – mainly with respect to the degree of market flexibility – producing different effects in the two areas in response to similar shocks, with specific implications for monetary policy. this interpretation does not deny the presence of some differences in the policy framework adopted in the two currency areas. for instance, the ecb ’ s primary objective of price stability and its mediumterm orientation imply scepticism regarding the appropriateness and efficacy of fine - tuning policies. in addition, the importance of monetary analysis in providing early warnings of price instability in the future, the strength of the central bank ’ s reaction to inflation expectations and the response of the yield curve to policy changes would indeed normally translate into differences in the setting of the policy instrument. however, these factors seem to be of minor importance when dealing with the specific criticism that has been voiced