s exposure is not high. of course, this does not mean that policy makers here can be complacent, as the current global financial turbulence is far from being over. furthermore, it is still unclear to what extent financial turbulence has set back the growth outlook of our major foreign trading partners. hungarian monetary policy cannot turn a blind eye to factors such as an increase in risk premia and a deterioration of global growth prospects. the most urgent problem central banks of small, open economies are facing seems to be imported price pressure. although these central banks have influence neither on global monetary conditions nor on the global output gap, with a floating exchange rate regime the importing of global oil and commodity price increases is not inevitable. imported inflationary pressure can be counterbalanced by nominal exchange rate appreciation ; this, however, does not constitute a free lunch, as it can temporarily contract activity in the tradable sector. an appropriate monetary policy response depends on what processes are responsible for global price increases. if the rise in food and oil prices is only a temporary phenomenon, the short - term inflationary effect of the shock can be accommodated. the possible second - round effects and inflation expectations, however, should be closely monitored. the less accumulated credibility monetary policy has, the more likely second round - effects will occur. for a central bank with relatively low credibility, pre - emptive measures may be necessary to stave off second - round effects, even if it does not wish to offset the direct inflationary effects of the external shock. if the change observed in relative prices is the result of lasting, structural causes, monetary policy will not be able to do anything about it in the long run. if the relative price changes remain permanent their effect will, on the one hand, appear directly in the consumer price index and may, on the other, lead to cost - push inflationary pressure on the relevant monetary policy horizon, due to the fact that the goods affected also serve as production input. furthermore, the risk of second - round effects will appear. compared to the transitory case, another difference is that a lasting change in relative prices can also lower potential gdp. because of this the central bank should, with the instruments at its disposal, strive to ensure that the change in relative prices takes place within the lowest possible inflation environment, and that a lasting inflationary pressure or a price - wage spiral will not occur. although creating a low inflation environment may entail some sacrifices in the short term, the advantages

policy and the policy rate without any political constraint and free of any political influence. this freedom of decision should also be supported through institutional and financial independence. in hungary, this framework is ensured by the central bank act. thus the mnb is an independent institution. it is also over the past twenty years that the majority of central banks have started to operate within the framework of inflation targeting. within this, monetary policy regards the explicit inflationary target as the nominal anchor which it commits itself to reaching, thereby striving to influence the expectations of economic agents. decisions about monetary policy will reflect the deviation of projected inflation from the announced target. in hungary, an agreement was reached in 2005 between the mnb and the government, setting the medium - term inflation target at 3 per cent in terms of the headline consumer price index. the majority of central banks pursue, explicitly or implicitly, an objective function which simultaneously takes into account the deviation of inflation from price stability and the evolution of the real economy, with more emphasis on the former. it is important to note that the evolution of the economy in this case represents deviation of current output from its longterm, potential level. the central bank, as i mentioned earlier, is in no position to influence the latter. this approach is entirely compatible with the forecast - based inflation target system. besides the evolution of inflation, central banks pursuing an inflation target also take into consideration real economic processes through various channels. inflation forecasts, serving as the basis of monetary policy decisions, reflect the effect of economic activity on inflation. in the case of an economic slowdown, for example, the output gap will widen and projected inflation will be lower accordingly. another channel is the specific time horizon assigned to a particular monetary policy : by making decisions which usually focus 1 - 2 years ahead, central banks setting inflation goals take into account the fact that counterbalancing temporary inflationary shocks in the very short run would result in unnecessarily high real economic sacrifices. following this brief theoretical introduction, let us move on to the current day - to - day challenges facing central banks. current challenges of monetary policy currently, the world ’ s central banks have to face two serious challenges. one is the subprime crisis, which broke out in the us and subsequently spiralled into financial turbulence on a global scale. the other is the significant increase in the prices of food, oil and other raw materials, which has led to a worrying inflationary pressure worldwide. global financial turbulence