by the sustained differentials in inflation among the euro area ’ s member states. it is true that these differentials are fairly small in comparison to the first half of the 1990s. however, following a substantial convergence in the run - up to emu, inflation differentials widened again. divergent economic developments are apparent in other currency areas, too, such as in the usa, without monetary policymakers being able to address this issue. monetary policy has to be geared towards the data for the currency area as a whole. it cannot address regional policy problems. otmar issing once coined that quite succinctly - “ one size must fit all! ” the member states had to accept that fact when they joined the third stage of european economic and monetary union. if persistent diverging trends emerge, either they have to be accepted, or, if detrimental economic consequences result, measures need to be taken at the national level. however, interest rate differentials also reflect the adjustment of the real exchange rate. but i do not want to elaborate much on inflation differentials. this issue will be covered in depth in tomorrow ’ s policy lecture by my colleague, hermann remsperger. 3. policy coordination and stability and growth pact the asymmetry of political responsibilities in emu makes a comprehensive system of coordination procedures indispensable. i believe this is undisputed. the rationale arises from the need to take account of the spill - over effects from national economic policies. consequently, the ec - treaty obliges member states to consider national economic policies “ as a matter of common concern ” and subject them to multilateral procedures. of all the coordination mechanisms, name recognition is highest for the stability and growth pact. the pact may not be popular in all places, but at least it is well known, albeit not well understood everywhere. i will later on try to illustrate why i remain an ardent advocate of the pact. however, the core coordination instrument are the broad economic policy guidelines ( bepg ). they contain the principal policy objectives and measures. they build the overarching structure for the more specialised coordination and consultation procedures. the guidelines make specific recommendations to each member state and to the community and are endorsed by the heads of state or government. however, they are politically but not legally binding and there are no really effective instruments for enforcing their implementation. due to the medium and long - term nature of many recommendations, measuring progress concerning implementation has become the main focus of the commission ’

john gieve : the return of the credit cycle – old lessons in new markets speech by sir john gieve, deputy governor of the bank of england, at the euromoney bond investors congress, london, 27 february 2008. the original speech, which contains various links to the documents mentioned, can be found on the bank of england ’ s website. * * * introduction the turmoil in credit markets since august has been novel in some ways ; but in others, the longer it has gone on the more familiar it has seemed. it has been looking less and less like the crystallisation of a “ tail ” risk – the “ unprecedented and unforeseeable ” event described by northern rock directors – and more and more like the unwinding of a wider credit boom during which risk premia had become unsustainably compressed. the excesses may have been most obvious in the complexities of structured credit and the sub - prime sector but they have not been confined to them. as in previous banking cycles, a period of strong growth, low interest rates and rapid increases in asset prices lead to over confidence and bad lending at the top of the cycle ; defaults, deleveraging and retrenchment follow in the downswing. but the way this old story has unfolded through the new credit markets has sprung some unpleasant surprises, including the speed with which losses in just one market in one country – the housing market in the us – have disrupted wider credit markets in all advanced economies. the upswing – a new structure of banking the roots of the problem lay in the so - called “ great stability ” of steady growth and inflation and in particular the last five years of persistently low nominal interest rates. the confidence born of that stability was combined with an increased institutional demand for fixed income and heightened international competition among the largest banks to develop scale. that led to a remarkable decline in corporate investment yields which was matched, and for a while seemed justified, by declining volatility ( see chart 1 which shows the fall the spreads and volatility of high yield bonds ). 1 and it put pressure on investors to find new ways of generating returns from credit. at the same time advances in it and financial modelling allowed the development of new derivatives, and the slicing, dicing and recombining of credits in new structured credit instruments. the search for yield would have made the us sub - prime mortgage market attractive to many investors. what made it irresistible was the financial engineering that