this will not be easy, but we should be able to rely on the well - established institutional and policy framework of the acquis and anchor our strategy to a clear end - point, the adoption of the euro. we, therefore, believe this to be a credible approach to euro area membership. in conducting monetary policy during this period, we recognize that international capital movements may present a growing challenge. for a long time, malta ’ s exchange rate peg was backed by controls on inward and outward capital flows but these are now being gradually phased out. in theory, full capital account liberalisation may lead to large and volatile capital flows which, in turn, may put pressure on the peg. in practice, econometric evidence suggests that, because of its openness, the maltese economy has already been exposed to significant capital flows. this, together with recent experience with a partially liberalised capital account, suggests that the impact of full liberalisation may turn out to be less than might have otherwise been the case. it is clear, nevertheless, that the central bank will have to adjust short - term interest rates – its key policy tool – to neutralise any pressures on the exchange rate. in other words, interest rates will not be able to respond to domestic economic developments, but will have to move in line with those abroad. nout wellink, ‘ the role of national central banks within the europeans system of central banks : the example of de nederlandsche bank ’, 30th economics conference, oesterreichische nationalbank, june 13 – 14, 2002. this would not, however, represent much of a change because already today the bank has only limited autonomy in the conduct of monetary policy. as far as the transition to the euro is concerned, therefore, the path that malta should follow seems fairly straightforward, given the starting point of the existing exchange rate regime. today, the basket consists of the euro, the us dollar and sterling, with weights of around 52 %, 26 % and 22 %, respectively. there is no fluctuation band. the peg is backed by official external reserves, which have comfortably exceeded the monetary base over the years and are equivalent to a fifth of broad money. the first step would be to increase the weight of the euro in the currency basket at the expense of either or both of the other component currencies. if the united kingdom were to join emu, this would automatically raise the proportion of the euro in the currency basket, making maltese entry

surprise. in other words, the 1936 episode might be considered as an example of a badly calibrated and badly communicated exit, rather than a wrongly timed exit. in this context, it is worth mentioning the 1994 episode, when the fed ’ s 25 - basis - point increase in its funds rate caused turmoil in the bond market. even with the benefit of hindsight, that decision can be regarded as neither tardy nor brutal. the problem was that it took markets by surprise and led to a major reassessment of the yield curve, with substantial valuation losses on long - term positions. these experiences confirm that not only is the timing of the exit crucial, but also its communication to market participants. indeed, the impact of any withdrawal of monetary stimulus on financial market participants depends on whether they have fully anticipated it. if they have, then the decision tends to have less impact on the yield curve, and thus on the valuation of banks ’ assets and on the rate that banks charge to their customers, especially on fixed rate loans. as confirmed by a growing body of literature, the main mistake relating to the 1936 – 37 decisions was that they were badly communicated to economic agents. 3 to sum up, a key element of the exit strategy is that the policy authorities must guide expectations. how can they do this? let me first of all consider how it should not be done. first, it may be better for central banks not to become embroiled in the debate on whether exiting too early or too late is better or worse, and especially not to give signals that the latter is less risky. such an approach could encourage market participants to become less riskaverse and to expect the period of low interest rates to be extended beyond what is necessary. this would induce them to take on further risks, in particular in terms of maturity mismatches – borrowing short - term to buy long - term bonds – which might be profitable in the short term but could lead to substantial capital losses when the exit takes place. ben bernanke, “ monetary policy and the housing bubble ”, speech at the annual meeting of the american economic association, atlanta, georgia, 3 january 2010. daniel leigh, “ monetary policy and the lost : decade : lessons from japan ”, imf working paper, october 2009. g. eggertsson and b. pugsley, “ the mistake of 1937 : a general equilibrium analysis ”, cfs working paper, november 2006. second, any commitment to prolonged periods