authorities are well aware of these risks and of the need to pursue financial reforms and economic policies that foster efficient and sustainable economic performance. to this end, exchange rate flexibility is an essential element of an appropriate policy strategy. exchange rate flexibility is also desirable in order to foster smooth, wide - ranging adjustments, based on market mechanisms, in the international financial system. moreover, such flexibility may also help china keep the pace of accumulation of foreign exchange reserves under control. for this reason, we at the ecb welcomed china ’ s decision to shift to a new managed floating exchange rate regime last summer. we expect the operation of the new exchange rate regime to contribute to global financial stability. however, while the size of speculative inflows appears to have diminished, the fact that current account surpluses are high and rising and that reserve accumulation is continuing unabated suggests that more adjustment is likely to be needed. such an adjustment would have to be well prepared as in the past, so as to contribute to global financial stability. we understand that greater exchange rate adjustment requires more reforms and that certain domestic considerations and constraints have to be taken into account. at the same time, we have observed, with great interest, the string of measures recently taken by the chinese authorities to prepare the country ’ s financial system to cope adequately with the new economic environment, including bank recapitalisation, partial interest - rate liberalisation, the introduction of trading in nonrenminbi currency pairs and the expansion of the forward market. the progress that is being made is very tangible indeed : only yesterday, for example, the people ’ s bank of china published rules that permit yuan interest rate swaps. such reforms are welcome not only because they can help the financial system to adapt to the new environment, but also because china ’ s substantial current account surpluses partly reflect the structure and features of its financial system. for instance, it has been argued that the saving rate in china is very high, even after the recent revisions of gdp data, because households need to save more for retirement and health care, but at the same time returns on financial assets are too low. moreover, as the availability of credit is also limited for households, they need to accumulate sizeable savings to purchase durable goods and houses. in this context, corporations, which account for a large part of total savings, have incentives to invest in real assets, including business capital, rather than to invest their cash flows in financial assets, because of the low returns offered by

corporations, the low level of interest rates has helped to improve their balance sheets after a period of excessive investment and borrowing. this restructuring, or repair of balance sheets, has been very important in the euro area. more recently, however, low interest rates have fuelled an increase in borrowing and a tendency of firms to borrow short term, rather than long term. but despite this development over the past year, the ratio of short - term to long - term obligations of euro area firms is not high. the flattening of the yield curve has exerted some pressure on bank profits. however, the profitability of euro area banks has evolved in a very satisfactory manner as a result of the positive influence of other factors, increased lending, especially mortgage lending, higher non - interest income and as a consequence of cost cutting and a reduction in the flow of provisions. low interest rates may encourage banks to increase their holdings of more risky assets and this could have implications if credit conditions change when interest rates increase. is that the same as saying that there are no risks to economic growth of rising interest rates? it is not the same thing, but under the present circumstances the consequences would be similar. with respect to the specific adjustment in the monetary policy stance of the ecb that took place earlier this month, i would not expect this to have a significant adverse effect, if any, on the ongoing economic recovery in the euro area. will the general global monetary policy tightening have an impact on euro area growth? in principle, a tightening of monetary policy – global and domestic - would be expected to contain aggregate demand growth. the extent, however, of this effect depends on the initial conditions and on the influence of a variety of other factors. in the us, despite the substantial increase in interest rates since the middle of 2004 which followed a fairly long period of low interest rates, economic growth has remained robust because of the cumulative impact of the previous monetary accommodation and of other factors that have at least partly counterbalanced the effects of higher interest rates. an important channel through which monetary policy influences the economy is through its effects on long - term interest rates. if long - term interest rates remain at a low level – as a result of favourable inflation expectations influenced by a credible monetary policy oriented towards price stability and as a consequence of the impact of other factors – then the effect on economic activity of a rise in short - term interest rates is going to be more muted. moreover, the expected strength of euro area economic growth in