so well, and the unique and innovative process we follow to ensure that it remains effective. finally, i ’ ll conclude with a discussion of important economic developments affecting economies worldwide. strengthening the framework to manage the potential risks these developments pose to the canadian economy is the key objective of our research over the next four years. the search for an anchor monetary policy needs a nominal anchor or a fixed point of reference to help tie down the expectations people have about inflation. during the 1960s, that anchor in most countries was a pegged nominal exchange rate that linked the value of domestic currencies to the us dollar. 1 this exchange rate arrangement, known as the bretton woods system, collapsed in the early 1970s, largely because of unsustainable inflationary pressure in the united states. without an anchor for monetary policy, inflation and inflation expectations rose rapidly, exacerbated by large oil price shocks. in some years, inflation hit double - digit levels in canada and in other advanced economies. economist milton friedman ’ s great insight into inflation is that it is always and everywhere a monetary phenomenon, which led him to claim that low inflation could be achieved by controlling the growth rate of money. he also emphasized that inflation expectations are influenced by monetary policy and that they eventually adjust to actual inflation. for this reason, he argued, there is no longrun trade - off between inflation and output. 2 thus, central banks should focus on controlling inflation. in 1975, the bank adopted a money supply target. but, by 1982, we were forced to abandon it — or, rather, it abandoned us, as former governor gerald bouey once quipped — after it became clear that financial innovations had weakened the bank ’ s ability to control the money supply and overall spending with its policy 1 in turn, the us dollar was convertible to gold at a rate of us $ 35 an ounce. 2 friedman ’ s analysis of inflation expectations and a vertical long - run phillips curve can be found in m. friedman, “ the role of monetary policy, ” presidential address delivered at the american economic association, 1967, and published in the american economic review 58, no. 1 ( march 1968 ) : 1 – 17. interest rate. 3 unfortunately, by then inflation and inflation expectations had risen and the expectations had become so entrenched that inflation declined only when the bank of canada and most other major central banks boldly increased interest rates in the early 1980s. it worked, but at the cost of a severe global recession

office of the superintendent of financial institutions ( osfi ), and the imf against results obtained from their own less complex models. the results generated by sophisticated internal models used by banks were broadly in line with those generated by the bank of canada and the fund. they showed that major canadian banks have enough capital to withstand a severe macroeconomic shock. this is useful information, but such simulations do not tell the whole story. for instance, they ignore important feedback from market participants. factoring these effects is no easy task, but it is a prerequisite to a full assessment of risk in the financial system. this is an active area of research at central banks, including the bank of canada, as well as at international organizations such as the imf. the bank of canada's contribution now, let me talk more specifically about the bank of canada's role in helping to maintain a robust financial system, the second of my five points. promoting financial system stability is a common goal for a number of public and private sector bodies, both nationally and internationally. in canada, the public sector responsibility is shared among a number of agencies including the central bank, the department of finance, osfi, the canada deposit insurance corporation, quebec's autorite des marches financiers, and provincial securities commissions. as canada's central bank, our key functions in the area of financial system stability are to provide liquidity to facilitate the settlement of financial transactions and to ensure that the risks of a systemic disruption in the payments and settlements systems are virtually eliminated. the bank also contributes to financial stability by providing an environment of low, stable, and predictable inflation through monetary policy. we use our key position at the centre of canada's financial system, our membership in international bodies – such as the international monetary fund ( imf ), the bank for international settlements, and the financial stability forum – and our extensive research capabilities to foster the safety, soundness, and efficiency of the financial system in canada and internationally. for example, the bank has been an active promoter of improved transparency in domestic markets and of imf reform – including strengthened imf surveillance – internationally. the promotion of financial system stability is complementary to our conduct of monetary policy in two ways : first, because monetary policy works through financial markets ; and second, because financial turbulence may affect aggregate demand and require a monetary policy response. for example, a reassessment of default risk that increases risk premiums and results in tighter credit conditions may