amongst other things, firms change their price - setting behaviour. in an environment of persistently high inflation rates, business owners pay comparatively less attention to current demand and more to expected future inflation when it comes to setting prices. taken in isolation, this can reduce the effectiveness of conventional interest rate moves, as the central bank mainly influences demand by means of changes in interest rates. in order to nonetheless tame inflation, the central bank therefore needs to act more decisively when tackling persistently high inflation – in other words, it needs to respond more strongly to a deviation of the inflation rate from its target. given the substantial uncertainty, it is not yet possible, in my view, to say how high the key ecb ( european central bank ) interest rates will increase. what is clear, though, is that if inflation becomes entrenched at a high level, there is ultimately a greater risk of a monetary policy response that would have sufficed in an environment of low inflation rates now no longer being enough to ensure that inflation expectations remain firmly anchored. and, as i explained earlier, unanchored inflation expectations stand out as one of the root causes of the great inflation in the united states in the 1970s. back then, the fed ( federal reserve system ) – in the face of persistently high inflation rates in particular – for a long time failed to tighten its monetary policy aggressively enough to anchor inflation expectations and stabilise price developments. it was only fed ( federal reserve system ) chair paul volcker who managed to cut the gordian knot of inflation. he did so by allowing short - term interest rates to rise to almost 20 % at the beginning of the 1980s. however, this came at a high price : the us ( united states ) economy slipped into two recessions in quick succession. to prevent an unanchoring of inflation expectations, the eurosystem should therefore not allow any doubts whatsoever to emerge in the first place over its determination to combat inflation. central banks could repeat the mistakes the fed ( federal reserve system ) made in the 1970s, above all in a situation where their response to inflation pressures is too little, too late. 5 concluding remarks ladies and gentlemen, in 2004, paul volcker, the “ slayer ” of inflation in the 1970s and beyond, was asked what he considered to be the most important legacy of the great inflation. he answered : “ don ’ t ( tonne ) let inflation get ingrained. once that happens, there ’ s too much

market forces. however, in my view, these calls for more of the former or more of the latter are in any case often misguided. periods of deregulation, ie more of the market, often culminate in a crisis. by the same token, periods of reregulation, ie more of the state, often lead to economic stagnation. this amounts to a choice between overheating on the hand and ossification on the other. poorly considered instinctive reactions are thus likely to take us down the wrong path. it is precisely for this reason that we should regard the simultaneous loss of confidence in the market and state as an opportunity to be grasped. an opportunity to move forward in our efforts to achieve stability. bis central bankers ’ speeches 2. more market orientation in the financial market financial stability is not a matter of choosing between the market and the state. rather, it is a case of finding the right relationship between the two. here, we can turn to the tried and tested principle of letting governments lay down the regulations while the market is allowed to function freely. the state defines the perimeter fence while the invisible hand of the market guides events on the playing field. upon first consideration this would seem to be a relatively simple construct. but is it really that straightforward in practice? clearly, it is not. especially with regard to the financial markets, the task is far from simple. there is a “ grey area ” in which the boundary between the market and the state becomes blurred. this grey area arises from the problem of systemic importance. participants in the financial sector are highly interconnected. these links start with the banks which lend money to one another and finish with complex derivative vehicles in which many players are involved. if a bank runs into trouble, this will also impact on all its counterparties. and if the bank in question is particularly large or has dealings with an especially large number of counterparties, its troubles can upset the balance of the entire financial system. we saw where this scenario led in 2008 when lehman brothers became insolvent. in cases like these, the state may have no choice but to rescue the bank concerned in order to prevent an escalation of the crisis. such rescue efforts are of course extremely costly ; in 2010, ireland was obliged to spend more than 30 % of its annual economic output on supporting irish banks. and these costs are ultimately borne by the taxpayer. but this policy not only comes at a cost to the taxpayer ;