play in the transmission mechanism of monetary policy is well known theoretically, although quite difficult to characterise empirically. monetary policy mainly controls the interbank overnight rate, which is not directly relevant for any material economic decision. the way to which monetary policy affects the real economy is when it impacts on relevant financial prices, i. e. when it moves the whole yield curve, or when it affects the exchange rate and other assets prices. there might be several channels through which the policy rate can affect asset prices or asset valuations : · first, changes in interest rate modify people ’ s expectations about future economic growth, and thus their profit expectations ; · second, monetary policy decisions may change the set of discount factors economic agents apply to their profit expectations or to the future stream of services or revenues from the asset they hold ( housing for instance ) ; · finally, interest rate changes may induce portfolios ’ shifts amongst assets that may in turn affect their relative prices. besides this, and for the sake of simplicity, i will call it the “ interest rate channel ”, changes in asset prices also generate wealth effects that may have a significant impact on several components of aggregate demand, namely consumption and investment. these wealth effects feed through to the economy via various channels, such as a direct increase in net wealth, which may lead to a rise in consumption because of households ’ inter - temporal smoothing behaviour ; via tobin ’ s q, which activates firms ’ investment ; or via an increase in the value of collaterals, which may reduce agents external financing constraints and enhance final spending, in accordance with the “ broad credit channel ”. although the evidence is mixed about the effectiveness of the wealth channel, even in the united states, it is likely to have increased over recent years. moreover, asset prices fluctuations or changes might also activate some confidence or expectations channels that may in turn influence households ’ or firms ’ spending decisions. for all of these reasons, asset prices have a particular role in the conduct of monetary policy. how should central banks react? does this mean that monetary policy should react directly to asset prices? or, more precisely, should asset prices be directly taken into account by the central bank ’ s reaction function? this issue is still debated amongst researchers and academics ; my feeling is that we should remain extremely cautious about it, perhaps because it would be like opening pandora ’ s box if we started setting our key policy rates according to asset price changes. another reason for being extremely cautious is that assessing asset prices ’ valuation

of major determinants of inflation – fully recognized by the governing council of the ecb. that is the reason why we rely upon a binocular vision of the factors of inflation, i. e. as a monetary phenomenon according to pillar 1 and as the result of short - term to medium - term developments of inflation according to pillar 2. this framework is also well suited to addressing the asset price bubble issue. in this context, the first pillar is very helpful for analysing how ample liquidity is within the euro area, that is to say how much the broad monetary aggregate ( m3 ) deviates from its reference value, and how economic agents make use of this liquidity : credit and loan developments are carefully monitored, in line with economical and financial developments. portfolio shifts are also an important part of the monetary analysis. too rapid a credit expansion to the private sectors associated with large portfolios shifts towards equities and a strong rise in stock or asset prices would, under normal economic conditions, signal the risk of a bubble formation. the second pillar consists of a wide range of economic and financial indicators : stock and bond prices, housing prices, exchange rates are also analysed in depth. obviously, their assessment is made in the context of maintaining price stability over the medium term, and the ecb does not react to their signals unless price stability is endangered. to recap, if monetary policy does not react directly to asset price developments or to an asset price bubble, it has clearly to take under consideration all the consequences of these developments on aggregate demand and aggregate supply, on economic agents ’ confidence and expectations, since they may at some point affect price developments. let me now turn to my second point, that is the implications of asset prices bubbles for financial stability. 2. implications for financial stability over the last decade, we have experienced several financial crises and contagion episodes : just to name a few episodes, the mexican crisis in 1994 - 1995, the russian - ltcm in 1998, the “ tech - bubble ” that ended in 2000, or more recently the financial crises in argentina and turkey. however, recent j. m guttentag and r. j herring ( 1986 ), “ disaster myopia in international banking ”, essays in international finance, 164, princeton university. research has shown that, if the frequency of financial crisis is not significantly different from what was observed in previous periods over the long run ( 1883 - 1998 ), recent episodes were certainly shorter