in a higher real capital stock, raising per capita income over time. but such ready provision of liquidity would trouble many people including, i suspect, most of my central banking forebears. an asset can be illiquid for several reasons, including genuine uncertainty about its underlying value. if private institutions took on additional liquidity risk, confident that the central bank would always help them out if liquidity conditions tightened, they could easily end up taking on more of these other risks as well. this would leave both them and the central bank in an awkward position at some future time should things take a turn for the worse. and for the central bank to act as a market maker of last resort in markets for more exotic instruments would be a very big step, potentially with many unforeseeable consequences. these are pretty big questions. i suspect that they will increasingly be debated over time. my own view, given what we know at present, is that in periods of particularly unusual market duress, central banks should be prepared to move beyond the normal scope of operations to provide liquidity against a broad range of assets and over a longer maturity than might normally be considered. there are two provisos. first, the central bank has to be able to make a reasonable valuation decision about the underlying asset, and take sufficient excess collateral ( a “ haircut ” ) to protect its own position. this probably rules out exotic instruments except under the most dire of circumstances. second, a preparedness for forceful intervention in a crisis situation has to be balanced with some thinking about ways of restraining developments in the other direction when risk appetite is high. that, needless to say, is no easy matter. the “ lender of last resort ” having talked about normal liquidity operations, we must then turn our attention to the role of lender of last resort, where the central bank lends to one specific entity, when no one else will. the first question is : why do we need it? the reason is the possibility – albeit a very remote one – that a panic could put overwhelming pressure on a perfectly sound institution that, though prudently managed, cannot possibly hold enough liquid assets to withstand the pressure unaided. some entity has to be prepared to lend in such a situation if the market will not, otherwise the panic can imperil the institution concerned, and perhaps the financial system as well. 5 the notion has quite a history. the earliest use of the term seems to have been

of such fundamental things as financial intermediation, credit growth, the exchange rate and real convergence in general. these are all very important factors that have to be taken into account when making a decision on the euro strategy or indeed on erm ii entry itself. it is therefore worth waiting with setting out very specific euro adoption plans for hungary until the dust settles at least a little bit. in the meantime, the slovakian experience with the euro, starting next year but showing its implications already in the recent unfolding of the crisis, will provide a good natural experiment for the other new member states, and will no doubt be closely watched.