be higher, the interest rate needed to be raised. of course, this rule could not capture all of the aspects of the monetary policy considerations, but it provided a rough explanation of the monetary policy decisions. see, for instance, apel, m. et al ( 1999 ), ” different ways of conducting inflation targeting – theory and practice ”, sveriges riksbank economic review, 1999 : 4, 13 - 42, svensson, l. ( 1997 ), “ inflation forecast targeting : implementing and monitoring inflation targets ”, european economic review, 41, 1111 - 1146 and batini, n., and e. nelson, ( 2001 ), “ optimal horizons for inflation targeting ”, journal of economic dynamics & control, 25, 891 - 910. see the minutes of the executive board meeting on 16 january 2007. this rule was easy to understand and in that respect it was a good educational tool. however, there were also disadvantages. in normal cases it is not, for instance, particularly realistic that the policy rate would remain unchanged a couple of years ahead. the assumption made it difficult to assess our forecasts and to compare them with those of other forecasters. the latter usually base their assessments on the policy rate being changed. it was also difficult to apply the assumption in a consistent manner in the forecasting process. these problems would have become worse when we extended our forecast horizon. moreover, it gradually became clear that this rule could sometimes be an obstacle in our communication. it created an exaggerated focus on the current interest rate decision and on the inflation forecast exactly two years ahead. the gradual shift towards more flexible monetary policy led to a greater need to illustrate the fact that it is the entire expected sequence of events for inflation and the real economy a few years ahead that is important in monetary policy decisions, and not only the levels we foresee two years ahead. and the focus should not only be on current interest rates, but also on expectations of future interest rate changes. 5 we left most of these problems behind us when we changed over in october 2005 to making forecasts based on market expectations of the future development of the policy rate. compared with the assumption of an unchanged repo rate, market expectations normally provide a much more realistic forecast. but the assumption that the policy rate will develop in accordance with market expectations also entails some difficulties. examples of problems include how one should measure market expectations and the communication of the interest rate path. it feels natural to move

##s. second, they have to restore confidence in, and stability to, the european financial system. third, they must deal with the remaining shortcomings in the institutional design of emu. let me elaborate on these factors in turn. first, the rebalancing of the euro area economies requires, first and foremost, that public sector expenditure is brought back to a sustainable path and that the debt overhang is reduced. this is, of course, particularly true for those euro area countries that are currently under an eu / imf programme or are experiencing disruptions in their sovereign debt markets. much remains to be done, but we should not forget the steps that have already been taken – although there is no room for complacency. based on a direct estimation of revenue and spending ( rather than on the cyclically adjusted primary balance ), the cumulative fiscal consolidation achieved thus far is in excess of 10 % of gdp in each of the three countries under eu / imf programmes. while some countries have, most regrettably, fallen behind the targets in their programme, the consolidation efforts are significant in absolute terms. one of the reasons why countries did not reach their headline deficit targets is to be found in the economic headwinds they are experiencing. negative economic growth, higher interest bis central bankers ’ speeches payments and higher social security spending have led to quasi - automatic increases in expenditure and obscure the fiscal consolidation efforts. this stresses the importance of the implementation of well - designed and ambitious fiscal adjustment programmes being accompanied by growth - enhancing structural reforms. there is no doubt that the long - term effects of fiscal consolidation on growth and employment are positive and significant. whereas fiscal consolidation may have a dampening effect on economic activity in the short run, the extent to which it does so depends on several factors, such as the composition of the fiscal adjustment. national authorities need to set ambitious and credible targets, and to stick to them. even small deviations from the targets can quickly jeopardise the progress made and undermine confidence. to address imbalances, countries also need to take structural measures and deal with market rigidities. suitable structural reforms can have a positive impact on growth and employment already in the relatively short term, and can thus also help to mitigate the negative effects of consolidation. structural adjustment nevertheless remains difficult, but not impossible. this is proved by the experience in the federal republic of germany over the past years. losses in competitiveness after the reunification boom in the early 1990s were