downwards. in that context, when demand falls, 2 % inflation allows real wages to adjust downwards even if nominal wages do not. that in turn helps keep unemployment lower than would otherwise be the case, and prevents the consequences of the downturn from lasting longer than they need to – for instance, by eroding the human capital of the jobless, leading to permanently higher structural unemployment. what is true within economies is also true across regions – and this is particularly so in a multicountry monetary union like the euro area. a 2 % inflation objective means that less competitive countries can lower costs and prices relative to the area average, which allows them to recover competitiveness without destabilising consequences. bis central bankers ’ speeches the need for such a buffer was explicitly acknowledged by the governing council in 2003 when we clarified our definition of price stability. 1 it has since helped countries to adjust competitiveness when required. initially, aiming at 2 % allowed some core economies to lower relative prices in a fairly painless way, as other “ catching up ” economies had higher inflation rates and were pulling up the area average. today, the positions of those groups have reversed. but the rationale remains exactly the same. the second reason why a 2 % objective helps absorb shocks is that it supports the implementation of monetary policy in adverse conditions. a small positive buffer creates more scope to support the economy through cutting nominal interest rates and reduces the likelihood of running up against the effective lower bound. this is because, for a given equilibrium real interest rate, a higher inflation objective implies higher nominal rates over the cycle. in line with the results from a larger research literature, ecb simulations made in 2003 suggested that a 2 % objective would substantially decrease the probability of nominal rates reaching zero. 2 this was also recognised by the governing council as a reason for aiming closer to 2 %. 3 what was true then has become even more relevant now. the studies in 2003 assumed an equilibrium real rate of around 2 %, so with a 2 % inflation objective the equilibrium nominal rate would be around 4 %. evidence suggests, however, that demographics - induced high savings and low productivity growth have led equilibrium real rates to fall. 4 aiming for 2 % inflation is hence even more crucial today to get nominal interest rates safely away from the lower bound. yet it is also important to stress that the fall in real rates is by no means pre - determined. it can be reversed at least in part by structural reforms that raise productivity and participation

potential, expanding opportunities, and improving well - being is a fundamental principle upon which our societies are built. in the case of the european union, the principle of an “ open market economy with free competition, favouring an efficient allocation of resources ”, is inscribed in those terms in article 120 of the treaties. it is also explicitly recalled in the statute of the ecb that everything we do has to be consistent with that principle. 2. why a free market depends on appropriate institutions but it is not enough just to open borders to have free markets. to reap the benefits of openness, markets require appropriate governance. indeed, a market stipulates not just the freedom to take part in the market, but also the means to protect that freedom. that means the confidence that contracts entered into will be enforced. it means the assurance that the rules of fair competition will be upheld, that property rights will be respected, that standards and codes will be applied properly. it means, in short, the rule of law. defined as the sum of world total exports and imports to gdp. there are, of course, many other reasons for net capital flows. for example, one would expect capital to flow from richer to poorer and less capital - intensive areas. bis central bankers ’ speeches for financial markets this is especially important given their inherent fragility. if rules and standards are not effectively applied, it can produce information asymmetries and other destabilising forces which, in turn, lead to sudden reversals of confidence in the market. we have seen in the past how markets have run ahead of regulation leaving them vulnerable to such dynamics. here is one illustration : during the crisis, the market for securitised assets was all but destroyed by a collapse of confidence. lack of oversight allowed excesses to be committed and market abuse to take place. securities that were previously deemed safe, certainly with some measure of complacency and too much blind confidence, turned out to be very unsafe indeed, and imparted significant losses on their holders. what is also unfortunate is that the subsequent attempts to re - regulate that market have threatened to undermine the parts that are beneficial to many. there was too much opacity as to the nature of the assets underpinning asset - backed securities, too damaging a breakdown of confidence in the integrity of those who packaged and sold them. and the immediate temptation of regulators was to impose punishing capital charges on holdings of asset - backed securities,