is further ahead. with the cpix again approaching the target range, it is relatively easily to somewhat superficially argue the merits of an inflation - targeting regime. some disadvantages of inflation targeting must, however, be acknowledged. whilst easily understood in terms of its objective, it is a complicated approach, more demanding and more difficult to implement than a monetary framework based on targeting monetary growth or a more discretionary framework. it implies greater reliance on forward indicators of inflation and a continuous assessment of the relationship between the instruments of monetary policy and the inflation target. where forecasts turn out to be wrong, even if for completely unforeseeable reasons, the central bank's credibility could be impaired. of course, the counterargument being that it simply makes visible the uncertainty that would remain hidden in other monetary - policy frameworks. inflation targeting, if pursued at any costs, runs the risk of inefficient output stabilisation. significant supply shocks to the economy such as sharp oil price movements, could require very large monetary - policy adjustments to bring inflation back inside the target range within the stated time horizon. for such exceptional events, some discretion and patience in re - achieving the target range should be allowed for. in this regard i wish to confirm that the reserve bank generally views it inappropriate to resort to the escape clause, and would rather provide an explanation to any deviation from the target range once the final outcome of the cpix average for that year had been published. this view is held so that the market has no doubt regarding the bank's vigilance and commitment to achieving its targets. indeed, following the cpix average for the year 2002, which could only be calculated early in 2003, where the average exceeded the target, an explanation was provided in the monetary policy review document of april 2003. ( the bi - annual monetary policy review is also available on our website ). the advantages of inflation targeting are also worth highlighting. firstly, transparency - the concept is easily understandable, with the ultimate policy objective translated into an explicit target value. secondly, inflation targeting provides enhanced clarity about the objective of monetary policy, which is conducive to sound planning in both private and public sectors. thirdly, the framework provides for improved accountability of the reserve bank. it eliminates the need to rely on a stable relationship between the money stock and inflation, which has become increasingly difficult to identify ; inflation targeting enhances economic policy co - ordination with government and the central bank

policy and financial stability fronts. we are only just beginning to understand what is prompting such a marked shift away from risk taking and the pursuit of yield to heightened risk aversion. a ready pool of investors and an appetite for risk appears to have encouraged substantial financial innovations and the creation of a new set of financial instruments, some of which ultimately proved to be a lot riskier than they initially seemed. much of this activity was concentrated in the us. the creation of these instruments involved the following elements which i only mention here, but are likely to be worthy of further study and analysis in years to come : • origination of credit on riskier terms. a clear example is the covenant - lite debt that private equity firms were able to obtain until 2007, and the increased flow of mortgage lending in the us that would previously not have occurred. • contracting out of origination, and securitisation of the completed loan, both of which have at least the potential to create moral hazard. • pooling of risk and assumptions about correlation which were based on historical data but did not always prove accurate ex post. • credit guarantees, often from the so - called “ monoline ” insurers. • the use of conduits by financial institutions to expand credit creation and asset holdings above and beyond the usual balance sheet constraints. • a relatively relaxed approach to liquidity risk, with an implicit assumption that wholesale funding was not at risk – as seen in the northern rock case, for example. these events are having important implications for smaller open economies, including new zealand, australia and the economies of scandinavia and eastern europe which have a substantial reliance on the international capital markets. most of these countries have not been very directly affected by the problems arising from the complex innovations described above. in new zealand, for example, we have not really seen the development of any of the complex financial instruments at the heart of the us ’ s current financial problems. however, as a net borrower and a participant in international markets, new zealand is certainly affected by the sharp changes in interest rates, credit spreads and exchange rates that have occurred as a result of recent developments. we are currently seeing increased funding costs in global markets for reasons that are largely not of our own making. we currently face something of a mixed bag at present in terms of global interest rates. at one level, a loosening in monetary policy in the us and some other countries is putting downward pressure on medium to longer - term interest rates. for