both moved higher since our last report. however, in view of the improving economic outlook, there is now a lower probability that the risks stemming from these vulnerabilities will be triggered. this combination of higher vulnerabilities but lower probability leaves the financial stability risks related to those vulnerabilities roughly unchanged from our last report. our view is still that a strengthening economy and rising incomes will reduce these vulnerabilities over time for the country as a whole. nevertheless, it was the view of governing council that this conclusion merited a caveat, which is that the pace of house price increases in toronto, and especially vancouver, is unlikely to be sustained, given underlying fundamentals. this suggests that prospective homebuyers and their lenders should not extrapolate recent real estate price performance bis central bankers ’ speeches into the future when contemplating a transaction. indeed, the potential for a downturn in prices in these markets, although difficult to quantify, is growing. a significant decline in house prices could have material consequences for some individuals and for some entities in the mortgage business. however, the financial system as a whole is resilient enough to handle the potential impact. the third financial vulnerability featured in the fsr is the fragility of fixed - income market liquidity. the empirical evidence is mixed, but there is considerable anecdotal evidence that fixed - income markets have become less liquid, in part as a consequence of regulatory reforms to safeguard the financial system. we believe that the system will eventually evolve in such a way as to make market liquidity more reliable over time. nevertheless, we will continue to monitor and study this issue, both in canada and with our international colleagues through the financial stability board and the bank for international settlements. all things considered, the governing council is of the view that financial stability risks overall have not changed materially since our last report. let me also mention two very interesting reports included in this fsr. the first is a portrayal of canada ’ s pension business, focusing on the eight largest public pension funds. canada is a global leader in pension fund management, and this article provides a comprehensive review of their activities. as major players in canada ’ s financial system, these entities warrant the bank ’ s interest, and i wish to thank those organizations for their co - operation as we prepared the article. the second report takes a look at the securities - financing market in canada and the implications of recent developments in that space for bond market

past two years. they are also the reason why the markets today see a potential for upward movement in the canadian dollar over time, thus allowing interest rates on maturities up to 30 years to remain below comparable u. s. rates. this is a view of the canadian dollar that we at the bank of canada share. these low canadian interest rates represent a substantial stimulus to domestic spending. because of the lags involved, it has taken households and businesses some time to respond. but now we have strong evidence, particularly from the interest - rate - sensitive sectors of the economy, that the consumer is back. and businesses continue to increase their capital spending. moreover, the latest surveys of consumer and business confidence point to continued expansion in domestic spending in coming months. what is particularly heartening is that total employment growth has picked up recently, despite the cutbacks in the public sector, and that the number of full - time jobs has increased significantly. altogether, it seems to me that the canadian economy has the potential for a long period of sustained growth in output and employment, with rising productivity and improving living standards. the challenge ahead what does monetary policy need to do to help realize this potential? with the economy gathering momentum, the challenge for monetary policy in the period ahead will be to encourage monetary conditions that preserve canada ’ s good inflation performance, because low inflation is a prerequisite for a durable economic expansion. experience has taught us that monetary stimulus which pushes too hard on the economy ’ s capacity limits for too long inevitably leads to rising inflation and painful boom and bust economic cycles of the kind we suffered in canada from the 1970s to the early 1990s. concern about inflation risks at this stage may seem misplaced. but monetary policy actions have their full effects on the economy with relatively long lags. so what we must be concerned with is not the current rate of inflation but rather what may happen in 1998 and beyond. to maintain a low and stable rate of inflation in the period ahead, we must conduct monetary policy in a forward - looking, pre - emptive manner. this means that we should be ready to take action early to ensure that, as slack is absorbed, the pace of economic activity converges smoothly with the path implied by potential output - - that is, the economy ’ s capacity to produce on a sustained basis. it is our view that the canadian economy should indeed absorb the existing unused capacity over the course of the next couple of years. thus, there will be a need to move to