holdings in many portfolios, including in particular official holdings of reserves. these expectations were probably overstated. history has shown us that once currencies achieve the status of an international vehicle currency, as the guilder and the pound did in previous centuries, the established infrastructure of deep and liquid markets favors their continuing to be so used. we have not yet reached the three - year mark since the euro appeared as a currency - - a very short time by standards of international monetary history. as i indicated earlier, we have seen substantial development in the markets for euro - denominated bonds and other fixed - income instruments. advancements in other markets have been slower but should proceed in time. i also note that the introduction of the euro created a motive for diversification into dollars for those investors who had previously obtained some portfolio balance by holding several european currencies. as stability between the exchange rates of those currencies increased through the late 1990s and then became absolute in january 1999, some investors were induced to substitute into dollars to regain the diversification they had lost as the euro - area currencies became more closely correlated. we are left with the question of how the international role of the euro will unfold. the attraction of investing in dollar - denominated assets depends upon relative rates of return. to the extent that the capital flows we have observed from europe to the united states are a critical piece of the story, the future will be determined, at least in part, by the success in europe of matching the expected rates of return on u. s. assets. but market pressures toward portfolio diversification are clearly also going to play a major role in the future relative positions of the dollar and the euro. the world can only benefit from the competition.

to adjust wages and prices in response to what they viewed as transitory changes in energy costs. in the final analysis, i think we probably saw some pass - through of higher energy costs into core inflation once price and wage setters came to believe that the rise in energy prices would not soon be reversed. but the magnitude of the effect has been small - perhaps on the order of a cumulative 1 / 2 percentage point or less since the end of 2003. if crude oil prices hold at close to current levels over the next few years, the resulting absence or even partial reversal of these energy cost shocks should, all else equal, put some modest downward pressure on core inflation. consumer energy prices have already flattened out according to the august data, and we will probably see a big decline in september's report. this decrease will not erase the increases of the past few years, but i believe that it will contribute to a lessening of consumers'fears that continued energy - price increases will lead to a ratcheting up of inflation in the long run. indeed, the most recent readings on inflation expectations from the university of michigan survey research center showed a noticeable decline in september, especially in the inflation rate expected twelve months ahead. in financial markets, the spread of nominal over indexed yields has also retreated substantially at the near end of the yield curve. to a monetary policy maker focused on the evolution of inflation expectations, these developments are indeed steps ( albeit small ) in the right direction. another major force driving up core consumer price inflation over the past year has been shelter costs, especially tenants'rent and owners'equivalent rent. together, these two components account for a substantial part of the core price indexes - 38 percent for the consumer price index ( cpi ) and 17 percent of pce prices - and as a result, small shifts in price trends in these areas can have a noticeable effect on core inflation. for example, after running at about a 2 - 1 / 2 percent pace for several years, increases in owners'equivalent rent stepped up to an annual rate of 5 percent in the six months ending in august. as you know, these prices are imputed from the rental housing market, and quite possibly this acceleration resulted from a shift in demand toward rental housing as higher interest rates and home prices, along with reduced expectations of capital gains, made the owner - occupied market increasingly less attractive. in response to greater demand, the supply of rental housing should increase over time, in part by drawing from the over