financial turmoil after 14 months of turmoil, global financial markets are at a critical juncture. risk aversion across the system has risen to unprecedented levels, and an aggressive deleveraging process is under way. many foreign financial institutions need to raise significantly more capital at a time when their ongoing earning power appears to have been permanently reduced. these dynamics could intensify the current global slowdown and will have an impact on the cost of capital in canada, despite the relative strength of our financial institutions. in order to illustrate the potential magnitude of these concerns, i would like to emphasize three points. first, the deleveraging process in the global system is far from finished. there are only three ways for a financial institution to reduce leverage : raise capital, sell assets ( at a price at or above their carrying values ) or restrain the rate of credit growth. over the past year, financial institutions in many countries have raised over us $ 350 billion of new equity, which covered only 70 per cent of announced losses. as a result, leverage has actually increased. with virtually all of these shares now trading below issue price, the ability of firms to raise capital appears very constrained. similarly, private asset sales have been limited by the complexity of the underlying assets, the ongoing impairment of securitization markets, difficulties in supplying financing to leveraged buyers and the desire of investors to " time the market. " in sum, banks have an increasing need for capital, but it has become more difficult to raise it. in this environment, the u. s. government's initiative to buy distressed assets is critically important. the plan announced by treasury secretary paulson and being developed through discussions in the u. s. congress is bold and timely. the size and breadth of support provided by this measure will help firms " rightsize " their balance sheets, re - liquefy closed markets and establish market prices for these distressed assets. this should eventually encourage private buyers to re - enter the market and complete the deleveraging process. a well - executed program will undoubtedly speed the resolution of this crisis and limit its economic cost. asset sales alone will be insufficient, and additional capital will still be needed. over time, acquisitions of the weak by the strong will play an important role. at the moment, valuation uncertainties, some accounting standards and investor caution are all restraining mergers and acquisitions in the sector. 3 in the end, reflecting the likely scale of the shortfall, it is possible that, in countries

prices is often due to aggregate demand being significantly lower than the total supply of goods and services in the economy. this type of situation can arise for two reasons : one is that demand could fall heavily, for instance, as a result of households for some reason reducing their consumption. the other is that supply could increase significantly, for instance as a result of technological advances leading to increased productivity. while demand - driven deflation is connected with weak production growth, the opposite applies to supply - driven deflation. these are usually termed “ bad deflation ” and “ good deflation ” respectively. in practice it is not so easy to distinguish between one sort of deflation and the other. problems arise when demand is too low in relation to supply. in my opinion, there could be a possibility that the increasingly skewed distribution of income that has arisen over the past 20 years, particularly in the united states, but also in europe and in ‘ emerging markets, has led to total demand being excessively weak from a global perspective. however, to the extent that the present low price pressure is due to good productivity growth and the increased supply of cheap goods and services from china and india, it can thus be termed “ good deflation ”. these positive supply shocks, combined with the declining rate of inflation, have led to an increasing number of analysts, including fed governor ben bernanke, recently drawing attention to the risk that the negative output gap could be larger than anticipated. this would mean that disinflation is more pronounced than we are currently assuming. the structural changes may have made it even more difficult to assess the economies ’ long - term growth potential and consequently to estimate total resource utilisation. it is, of course, a complicating circumstance that factors a central bank has difficulty in identifying and controlling are important to inflation trends, in both the short term and in a longer perspective. however, there is at the same time a lot a central bank can do to prevent excessively low price increases and to parry the increased complexity following in the wake of globalisation. here i would in particular like to emphasise the importance of having a symmetric inflation target that functions as a clear, credible target for participants in the economy. i would also like to emphasise the importance of central banks ’ communication in a low - inflation economy, as it is then particularly important to create stable, positive inflation expectations. risks of deflation an interesting, but possibly hypothetical, question is whether there is