policy that ignored the potential drag on future demand from asia could risk magnifying the effect of the shift in aggregate demand. rule no. 4 : the appropriate policy response may depend on the source and persistence of the shock. let me distinguish two types of shocks to the economy. the first is a persistent demand shock - - for example, an increase in aggregate demand that results in a persistent departure from trend growth and persistent changes in utilization rates. this will have symmetric effects, raising both output and inflation, and presents a relatively straightforward monetary policy problem that is well handled by the first set of rules. a second source of shock is a supply shock, an example of which would be a one - time, permanent increase in oil prices. we have had several examples of very sharp increases in oil prices, especially in the 1970s, and, more recently, oil prices have been declining since the end of 1996. when there is a sharp rise in oil prices, there will be a temporary burst of inflation. in addition, an adverse supply shock will typically result in a decline in aggregate demand and hence in output and employment. this is thus an example of a situation in which there can be a conflict between the dual objectives of full employment and price stability, and, as such, this represents one of the greatest challenges for monetary policy. the surge in inflation appears to demand a rise in real interest rates, and hence a particularly sharp increase in nominal rates ; while the decline in output and employment appears to call for a decline in real interest rates. experience suggests that supply shocks yield a sharp transitory increase in inflation, often followed by a smaller, more permanent effect, though the longer - run effect on inflation will obviously be importantly dictated by the response of monetary policy. given the transitory nature of the initial inflation surge, policy does well to look through it and instead focus on the more persistent ( and modest ) inflation consequences of the shock. by doing so policymakers respond expeditiously to the bad news, but avoid the mistake of overreacting. - 9one reason for this cautious approach is that policy cannot much affect inflation in the near term, but instead has its primary effect over the coming year or two. hence policy today should focus on inflation next year. policy should tighten, that is real interest rates should rise, to the extent that inflation is expected to be higher next year on account of the supply shock. this might reflect the effect of a supply shock as today ’ s oil prices raise

i will not dwell on it here ). anyway, despite all of this, the banks have also had to change gear and become heavily involved in loan recovery and the associated task of balance sheet restructuring of many of their distressed corporate ( and individual ) customers. but can one improve on having the banks as the engineers of restructuring? this question was widely discussed around the turn of the millennium, as researchers and practitioners tried to draw lessons applicable to the east asia crisis ( which hit half a dozen rapidly growing countries in 1997 – 8 and left a debris of corporate insolvencies ), and from the earlier experience of banking crises in japan, scandinavia and the united states, as well as some other developing countries cases. the broad conclusion from this debate 3 was that centralised asset management companies, as in sweden and with the us resolution trust corporation, can work well where what needs to be restructured is mainly a class of property companies. this is because the main assets of the companies are relatively easily transferred and do not depend on a specialised production chain, patents, firm - specific know how and so on. to overstate somewhat, the value of real estate may, especially in a downturn, be pretty much independent of who manages it. in a rising market, the swedes managed to do well in realizing their property portfolio over time. the international literature also warns, however, that large state - owned amcs can become vulnerable to improper political pressure, especially where large and prominent firms have become bankrupt. fortunately there is no evidence of such pressure occurring in respect of nama in the current irish crisis, and indeed the legislation setting up nama has built in protections against such pressures. on the other hand, non - property related distress may ( according to the international research ) best be managed by the banks themselves. specific company know - how can help in devising the best solutions for maximising the value of the firm ’ s assets – provided that the restructuring process can be insulated from the denial and over - optimism that may have contributed to poor loan underwriting in the first place. the banks in turn need to be provided with sufficient capital to allow them to fearlessly accept and crystallise the unavoidable loan - losses, sufficient liquidity to be able to provide further financing to set the restructured firm back onto a healthy growth path, and eventually move it out of the limbo of financial distress. as against all of this, it has to be acknowledged that few bank staff start