that they are difficult to redress. and it must be acknowledged that here a good deal of progress has been made over the past year. the unfolding of the crisis has shown that the governance model in place to date in the eu has been of no use in ensuring economic policy consistency or in managing crisis episodes flexibly and effectively. it ’ s now clear that public finances were not sufficiently restructured in the upturn, that macroeconomic divergences were excessive and that we need a well - designed financial aid mechanism to assist ailing countries swiftly and effectively. mindful of this, european governments and institutions have taken major steps towards correcting deficiencies in three fundamental areas : the strengthening of fiscal discipline, closer surveillance of macroeconomic maladjustments and the creation of a permanent crisis - management framework. starting with fiscal discipline, public debt levels will be more closely monitored and countries will have better incentives to comply with their commitments, through the introduction of broader and transparent sanctioning arrangements, which will moreover be applied at an earlier stage and, as far as possible, automatically. further, the reform of national fiscal frameworks is being promoted, so that budgetary policy rules and surveillance systems will be adopted that help curtail spending. moreover, a new framework for the prevention and correction of macroeconomic imbalances is being established. the aim of this mechanism is the early identification of the emergence of potentially “ excessive imbalances ”. when imbalances are considered to be too big, an excessive imbalance procedure will be initiated which will include recommendations for the adoption of corrective measures. the third key element of eu economic governance reform is the creation of a permanent crisis - management instrument, the so - called european stability mechanism, which will come into force in mid - 2013. geared to lend up to €500 billion, this mechanism will provide funds to countries with liquidity problems under strict conditionality. finally, a mention for the euro plus pact, approved in march by the euro area heads of state and of government. this pact involves a commitment at the highest political level to adopt the measures needed to attain competitiveness and employment - promoting objectives, to contribute to the sustainability of public finances and to reinforce financial stability. there ’ s always room for improvement and, at the ecb, we have called on heads of state to strengthen governance procedures further, for instance by making sanctions more automatic in cases of non - compliance so as to prevent governments succumbing to the temptation of being

. how is the inflation tax imposed? governments have appointed either central banks or currency boards as their agents for producing and supplying currency. unlike currency boards which have to maintain a hundred percent reserve of valuable assets ( gold and hard foreign currencies such as dollars, euros or sterling pounds ) for issuing currency, central banks are peculiar animals. they do not have to have a reserve of an equivalent amount and can issue currency simply by making book entries. in other words, they can acquire any asset by assuming a liability on account of the currency they have issued. for instance, if a central bank has to acquire a building, all it has to do is to open its vault and issue the required amount of currency to the seller of the building. after the transaction, the central bank has a building on the asset side of its balance sheet. but, at the same time, on the liability side, there is an equivalent amount representing the currency issue of the bank. governments impose inflation tax on the society by borrowing from central banks. when such borrowings are effected, the government would give the central bank a government security such as a treasury bill. the central bank, in return, permits the government to take away an equivalent amount of currency and spend it to make payments. so, on the asset side of the bank ’ s balance sheet, it has a treasury bill. on the liability side, this asset is matched by a new liability called currency issued by the bank. but, to acquire that asset, the central bank has to spend only a fraction of the face value of the asset enabling it to make a huge profit out of the transaction. central banks ’ lending to governments become highly inflationary on another count. that happens when the commercial banks make use of this currency issued by the central banks as seed money to produce more bank money in the form of deposits. when governments spend the currency borrowed from central banks, such currency finally gets back to commercial banks as deposits of the public. commercial banks, in turn, use such deposits to create more deposits and credit. they create deposits and credit in multiple terms restricted only by the public ’ s preference for currency as against deposits and banks ’ own need for keeping a safe cash reserve to meet public ’ s demand for cash. in sri lanka, commercial banks could create bank money five times higher than the initial amount of currency issued by the central bank. because of this ability to self - produce in multiple terms, ( in sri lanka, that multiplier