through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both keynesians ( tobin, 1969 ) and monetarists ( brunner and meltzer, 1973 ). recently, javier andres, j. david lopez - salido, and edward nelson ( 2003 ) have shown how these effects might work in a general equilibrium model with optimizing agents. the practical importance of these effects remains an open question, however. quantitative easing may also work by altering expectations of the future path of policy rates. for example, suppose that the central bank commits itself to keeping reserves at a high level, well above that needed to ensure a zero short - term interest rate, until certain economic conditions obtain. theoretically, this action is equivalent to a commitment to keep interest rates at zero until the economic conditions are met, a type of policy we have already discussed. however, the act of setting and meeting a high reserves target is more visible, and hence may be more credible, than a purely verbal promise about future short - term interest rates. moreover, this means of committing to a zero interest rate will also achieve any benefits of quantitative easing that may be felt through nonexpectational channels. lastly, quantitative easing that is sufficiently aggressive and that is perceived to be long - lived may have expansionary fiscal effects. so long as market participants expect a positive short - term interest rate at some date in the future, the existence of government debt implies a current or future tax liability for the public. in expanding its balance sheet by open - market purchases, the central bank replaces public holdings of interest - bearing government debt with non - interest - bearing currency or reserves. if the open - market operation is not expected to be reversed too quickly, this exchange reduces the present and future interest costs of the government and the tax burden on the public. ( effectively, this process replaces a direct tax, say on labor, with the inflation tax. ) auerbach and obstfeld ( 2003 ) have analyzed the fiscal and expectational effects of a permanent increase in the money supply along these lines. note that the expectational and fiscal channels of quantitative easing, though not the portfolio substitution channel, require the central bank to make a credible commitment to not reverse its openmarket operations, at least until certain conditions are met. thus, this approach also poses communication challenges for monetary policy makers. japan once again provides the most recent case study. in the past two years,

mr. george gives an address on recent changes in the international financial and economic environment speech given by mr e a j george, governor of the bank of england, at a dinner with the lord mayor for bankers and merchants of the city of london on 10 june 1999. my lord mayor, mr chancellor, my lords, aldermen, mr recorder, sheriffs, ladies and gentlemen. when we were last here for this splendid occasion i suggested that we were living in a dangerous international financial and economic environment. these were strong words for a central banker – but perhaps not strong enough. that environment rapidly became worse through the autumn, so that by around the time of the imf annual meetings in october there was a good deal of talk about global financial meltdown and impending world recession – which was not simply journalistic hyperbole. since that low point things have certainly improved. the hectic scramble for financial asset quality and liquidity following russia ’ s default and the near collapse of ltcm – an exceptionally highly geared hedge fund – failed to uncover fatal weaknesses elsewhere in the financial system, and lenders and investors have gradually regained some of their appetite for risk. fears of a general credit crunch in major industrial countries quickly receded ; and sentiment towards the emerging markets has improved, with growing evidence of recovery in the original asian crisis countries and a better than expected outcome in brazil. among the industrial countries, japan made stronger efforts to bring its long recession to an end – through macro - economic stimulus and by strengthening its domestic banking system – and there are now signs that those efforts are beginning to be rewarded. meanwhile the world economy has been effectively underpinned by continuing abnormally strong domestic demand growth in the united states. but despite these developments we still have a long way to go. if the immediate danger of global financial instability has receded, we are still stuck with slow growth in the world economy, currently at around 2½ %, which is not much more than half the estimated trend growth rate. and we are stuck, too, with massive international imbalances, both between the emerging and industrial countries, on the one hand, and among the major industrial countries, on the other. without a stronger resumption of capital inflows to the emerging markets, the industrial countries will need to accommodate an export - led recovery in those markets. that implies stronger domestic demand, and hence import, growth in the g7 countries, if the world economy as a whole is to get back on trend