rate is 2. 5 per cent, and that inflation is at the objective and output at potential ( or the unemployment rate equal to the nairu ). if a large contractionary shock occurred, the central bank could then reduce interest rates by at most 450 basis points. 16 if the inflation target was raised by 1 per cent, the argument goes, central banks would have been able to cut interest rates by an additional 100 basis points, which, given that many central banks have reduced rates to ( almost ) the zero lower bound, would have enabled them to provide more stimulus. while true, most observers do not find this argument compelling. 17, 18 raising inflation objectives would increase average inflation rates and therefore inflation volatility and price dispersion, which is costly. seeking to achieve more room for large interest rate cuts also presumes that there are no other policies that can be used to stimulate demand if the zero lower bound it reached. however, during the crisis central banks have shown great ingenuity in designing new policy tools, although, admittedly, uncertainty remains about their bean ( 2008 ) lists a number of causes, including a failure by regulatory and supervisory authorities to appreciate the risks inherent in the ‘ originate - to - distribute ’ model ; opacity in risks underlying complex structured finance assets ; excessive reliance on statistical models of risk based on past behaviour ; overdependence on ratings by investors and a failure to observe due diligence ; excessive closeness of the ratings agencies to those who were issuing debt ; compensation schemes in financial institutions that stimulated risk - taking ; and a focus on short - term returns. as a point of comparison, the peak rates during the last interest rate cycle were 4. 25 per cent for the ecb ( july 2008 - october 2008 ), 5. 75 per cent for the bank of england ( july 2007 – december 2007 ) and 5. 25 per cent for the federal reserve ( june 2006 – september 2007 ). see bean et al. ( 2010 ) and kohn ( 2010 ). when asked by a journalist for his thoughts on the issue, jean - claude trichet ( then ecb president ) described the idea of a 4 % target as “ plain wrong ”. ( http : / / www. ecb. int / press / pressconf / 2010 / html / is100304. en. html ) bis central bankers ’ speeches effectiveness and how best to apply them. nevertheless, it is difficult to argue that short term

the early part of the year, some strengthening appears to be taking place during the spring. looking ahead, the governing council expects real gdp to expand at a moderate pace. the ongoing recovery at the global level, and its impact on the demand for euro area exports, should provide support to the euro area economy. at the same time, the financial crisis is expected to have a dampening effect on economic growth given the ongoing process of balance sheet adjustment in various sectors and the expectation of low capacity utilisation and weak labour market prospects. the governing council continues to view the risks to this outlook as broadly balanced, in an environment of high uncertainty. on the upside, the global economy and foreign trade may recover more strongly than projected and confidence may improve more than expected, with the result that the recovery becomes self - sustained. on the downside, concerns remain relating to renewed tensions in some financial market segments. in addition, a stronger or more protracted than expected negative feedback loop between the real economy and the financial sector, renewed increases in oil and other commodity prices, and the intensification of protectionist pressures, as well as the possibility of a disorderly correction of global imbalances, may weigh on the downside. with regard to price developments, euro area annual hicp inflation was 1. 5 % in april 2010, according to eurostat ’ s flash estimate, after 1. 4 % in march. this is somewhat higher than expected a few months ago and appears to be related, in particular, to upward pressure in energy prices. looking ahead, global inflationary pressures may increase, driven mainly by price developments in commodity markets and in fast - growing economic regions of the world, while euro area domestic price pressures are still expected to remain contained. as a result, overall inflation rates are expected to be moderate over the policy - relevant horizon. inflation expectations over the medium to longer term continue to be firmly anchored in line with the governing council ’ s aim of keeping inflation rates below, but close to, 2 % over the medium term. in the near term, given the developments in energy prices, risks to earlier projections for hicp inflation are tilted somewhat towards the upside, while risks to price stability over the medium term are viewed as still remaining broadly balanced. upside risks over the medium term relate, in particular, to the evolution of commodity prices. furthermore, increases in indirect taxation and administered prices may be greater than currently expected, owing to the need for fiscal consolidation in the coming years.