with respect to unconventional monetary policy tools, let me first step back just five years in time, by quoting former fed chair ben bernanke. he famously quipped that balance sheet instruments, such as qe, work in practice, but not in theory. 2 indeed, central banks implemented unconventional monetary policy instruments at a time when the workhorse macroeconomic models could not be used to assess their expected impact. the models typically had a zero lower bound on interest rates, excluding the possibility of a negative nominal policy rate. modelers struggled with a “ forward guidance puzzle ”, which implied that communication on future policy rates had implausibly large effects on the economy. and last but not least, financial transmission channels like the ones that pass - through the banking sector were poorly modelled. since bernanke ’ s quote, a burgeoning academic literature has increased our understanding of them. we now typically talk about the effective lower bound of policy rates, which can be below zero. models with incomplete information now show that forward guidance is useful, although not almighty. the modelling of the financial sector is more advanced. furthermore, academic research has mapped out the circumstances in which balance sheet policies can have an impact on the economy. so we can now conclude that they can have an impact in practice and in theory. that being said, the exact circumstances in which balance sheet instruments are effective warrants some further detail. in the last decade many different types of balance sheet instruments have been implemented by central banks. the literature tells us there is one feature that binds them : frictions in financial markets that imply imperfect asset substitutability or market segmentation. these frictions are crucial for these instruments to have an impact on financial conditions. such imperfections can be thought to exist between any two types of assets, giving rise to different risk premia, such as a term premium on long - term bonds, a risk spread on corporate bonds and a liquidity or safety premium on liquid and safe bonds. these frictions shape the impact of central bank interventions on financial conditions. the main message from the theoretical literature on central bank balance sheet policies is that central banks can alleviate financial frictions by intervening directly in financial markets. by increasing its role as an intermediary, a central bank can effectively suppress risk premia, which leads to an easimngof financial conditions for households and firms. 3 this is actually what we have observed in practice. however, there is an important catch : the relevant friction

addition, many of the borrowers used to be companies with close ties to the government. as a result, there were few incentives for risk control and return enhancement. instead, some banks used to generate profits by exploiting certain privileges which no longer exist. what is necessary, and what has been done to some extent in some countries, but not all, is privatizing state - controlled banks and promoting free market entry. this will provide bank managers with the right incentives to make risk / return assessments. adequate bank supervision and financial markets oversight are required to ensure that sufficient weight is given to risk control. foreign ownership may help to transfer certain specific banking skills to candidate member states, even though i do not favour a big january sale of financial institutions in the countries concerned. the current problems in certain asian countries show that a bad loan overhang can severely impede the functioning of the economy. balance sheet restructuring in countries in central and eastern europe may require intervention by the competent authorities in some cases. it may be necessary to let some banks fail. it may be necessary for governments to take over bad loans inherited from the communist era. this would enable some credit institutions to conduct business more effectively. in order to prevent moral hazard, the rescue of selected credit institutions can only take place under certain conditions, most likely including the lay - off of those responsible for making these loans. importantly from a macroeconomic point of view, any debt restructuring involving government money should find expression in official figures for government debt. this would provide a better insight into the actual financial situation in the countries of central and eastern europe. reducing uncertainties in this respect is likely to build up confidence and attract rather than deter foreign investors. – 5 – concluding remarks i have spoken on the monetary relations between the euro zone and the countries of central and eastern europe. let me conclude by presenting some ideas about the relations between the european system of central banks ( escb ) and the central banks of the candidate member states. although candidate member states obviously cannot take part in escb meetings before their accession to the european union, it could be useful to invite the governors of the central banks of the “ fast - track ” countries once a year to attend a special meeting of the general council of the ecb. this would be similar to the current practice for the council of economics and finance ministers ( ecofin ). apart from that, the ecb staff could be asked to make a yearly assessment of the state of progress in applicant countries. finally,