philips curve trade - off. with inflation expectations well anchored, any given shock to inflation – coming from aggregate demand, energy prices, or the foreign exchange rate – would have a smaller effect on expected inflation and hence on trend inflation. however, this favourable set of circumstances has co - existed until recently with numerous signs of over - abundant monetary and market liquidity : robust money and credit growth ; high transaction volumes and small bid - ask spreads ; low credit spreads and term premia ; and reduced volatility across virtually every asset class. those vulnerabilities have not gone unnoticed by central banks, as testified by past analyses in the ecb financial stability review publication. although market sentiment had proved extraordinarily resilient to events which in the past would have triggered sharp corrections ( including the shift to less accommodative monetary policies in the major economies ), the analyses identified the risk that the prolonged period of low rates might have created incentives for excessive risk taking and that a sudden tightening might leave, using rajan ’ s words 6, “ a number of participants stranded on a limb of illiquidity ”. in my view, all of this warns against excessive focus on a fixed, excessively short - term time horizon for inflation targets. the eurosystem ’ s monetary policy strategy abstains from specifying a fixed time horizon for policy. through its diversified approach, it also accords due importance to assessing medium - to long - term risks to price stability. it is therefore well equipped to deal with the perils of short - termism, the temptations of excessive fine - tuning and the risks of asymmetric responses during upswings and downturns. it also permits appropriate account to be taken of the endemic pro - cyclical characteristics of the financial system and of boom - bust cycles in asset prices, and to consider under very specific, exceptional circumstances a policy of carefully leaning against the wind, despite the wellknown intrinsic difficulties of identifying misalignments in real time. the role of forecasts in policy making inflation forecasts are at the centre of inflation targeting strategies. policy discussion and communication are organised around the forecast process, and decisions are often explained on the basis of deviations of the inflation forecast from an inflation target at a see, for instance, w. r white ( 2006 ) : “ is price stability enough? ” bis working paper, no 205. remarks at the conference on central banks in the 21st century, banco

first century. in this regard, the basel committee has pledged to monitor industry developments and to continue its public dialogue on emerging issues that are relevant to capital supervision. the basel committee has already begun to honour this promise, in two areas especially. one topic that we are discussing with the industry is the treatment of “ double default. ” some industry representatives believe that basel ii takes an overly conservative approach to the risk of loss associated with exposures covered by guarantees : they suggest that the risk of both a borrower and a guarantor defaulting on the same exposure is lower than the risk of just one party defaulting. the committee believes that the new framework should recognise some double default effects, and we are currently considering all of the implications of doing so, including those associated with measuring the effects. another topic we are discussing with the industry concerns the treatment of certain trading - related issues under basel ii. in the view of some industry representatives, neither the existing market risk capital rules nor basel ii go far enough in recognising advances in the measurement and management of risks arising from trading activities. we are evaluating these matters. our work on double default and trading book matters is making good progress. we are consequently confident that we will issue papers for public discussion on these topics by early april this year so that we can finalise the rules during the summer, with a view to allowing their implementation at the same time as the rest of the new framework. as chairman of the basel committee, i would of course like to see consistent implementation of these changes on an international basis, both in terms of content and timing. also from a european perspective, i believe that the eu should seek to implement the trading book changes at the same time as other major countries. moving now to the second initiative, the basel committee has long intended to conduct work to re - confirm that the new framework meets our objective to broadly maintain the aggregate level of capital requirements, while keeping incentives to adopt the more advanced approaches that are offered. in order to establish a common data set on which to base this review, the committee has decided to begin a recalibration exercise in autumn this year, some months earlier than anticipated. as i said earlier, i don ’ t believe that this will imply a significant change to the framework. we are already satisfied that the new capital framework clearly differentiates the degree of risk in particular transactions on a relative basis. what we need to confirm is that the absolute requirements are right and that the appropriate incentive