process of disinflation. in part, this is being fostered by international developments in the prices of commodities and crude oil – incidentally, with quite positive terms of trade effects for the oil - importing euro countries. in germany, for example, core inflation is about 1 %. – 3 – ‘ deflation is not on the agenda, ’ stanley fischer, the imf ’ s deputy managing director, recently underlined. the present price stability and the low level of interest rates in the capital market indicate the absence of inflation expectations. that provides the opportunity for longer - term inflation - free growth. iii if it appears rather unlikely that the crises in parts of the world economy will spread to america and europe through the real economy, is it not possible – given a loss in confidence – that this could happen through the channel of the financial markets? keyword ‘ credit crunch ’ a number of observers fear, for example, that the current uncertainties in the financial markets might cause financial institutions to refuse financial resources even to first class borrowers in future – with matching implications for investment and growth. there would be various reasons for that : • first, financial institutions change their risk preferences, especially as a result of disappointed confidence or an expected recession. at least for a while, there may be a higher risk aversion overall. • second, financial institutions find themselves subjected to an erosion of their capital base. they then have to show restraint in terms of further exposures – even to top - rated borrowers – in order to restore appropriate financial ratios. a rise in the cost of equity can even reinforce that. • third, the assets deposited as collateral decline in value, say, as a result of a fall in asset prices in the real property or equity markets. in some cases, however, what is worrying about a credit crunch is the idea that the normal price mechanism balancing supply and demand is being paralysed in the credit market for specific reasons. in a ‘ credit crunch ’ scenario – so the theory goes – financial institutions do not respond to a rise in demand for credit by raising the lending rate and extending their supply of credit. that is because they fear a disproportionate rise in the share of demanders of credit with comparatively risky projects – the keyword is ‘ adverse selection ’. moreover, after receiving credit, the debtors would have an incentive to enter greater risks – the keyword is ‘ moral hazard ’. if banks have difficulty in assessing their

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