impossible to implement fiscal stimulus measures. on the contrary, in order to secure long term sustainability, a significant fiscal adjustment took place, which was necessarily pro - cyclical in the short run. the fiscal adjustment also contributed to the dramatic adjustment that took place within the private sector. households increased their net savings, while firms cut down on their investments, which resulted in a strong trade balance surplus, and a net financing capacity towards the rest of the world. the financial gap was closed. in less than 18 month the external finance position improved by more than 8 %. it must be stressed, that when the crisis hit, countries relying heavily on external funding to finance their growth suffered a more severe recession in 2009, in contrast to those where growth was financed by domestic savings to a greater degree. as it appears unlikely that investors ’ risk appetite will return to pre - crisis levels for quite some time, over the medium term, the process of real - convergence cannot proceed at the expense of a significant deterioration in external balance. we need a new growth model. we have to rely mostly on domestic savings. neither monetary policy was in a position to act strongly against the sharp downturn, due to the high expected risk premium and the currency mismatch problem. however, from the outset the central bank introduced liquidity support measures, and after risk appetite seemed to be stabilizing, we begun to lower or policy rates gradually, keeping in mind that we must not let sudden movements in risk appetite to translate into potentially destabilising balance sheet effects. how can we address these vulnerabilities, that are a threat in themselves but also constrain the effectiveness of economic policies so much? there are no quick fixes here. while the pre - crisis level of indebtedness of households was not particularly high by international standards, its currency composition became very risky. the debt burden increased significantly due to the weakening of the forint - euro exchange rate and the strengthening of the swiss franc. the currency mismatch on private sector balance sheets took years to build up and cannot be undone easily. there is no simple way of converting foreign currency debt to domestic currency debt. if government takes over, it would only mean a transfer of risks, but not elimination. if the conversion would take place directly and en masse on the foreign exchange market, this would almost certainly imply large exchange rate depreciation and possibly other unintended consequences. moreover it is hard to imagine indebted households that

the same mistakes. it decided to use some of the excess revenue to repay domestic and off shore debt. this is equivalent to a future generation fund. reducing debt today reduces the burden on future generations when the debt becomes due. it also decided to place some of the excess revenue in trust accounts to be used as a stabilization fund. this decision has had some flaws, the first is that the use of the funds were not tightly controlled and regulated by law. the second is that the funds were deposited with the commercial banks at a very low interest rate, and the bank of papua new guinea has had to defuse them to ensure that the excess liquidity will not result in very high inflation, by using central bank bills ( cbb's ), at a much higher interest rate cost to the benefit of the commercial banks. just to give some indication of the magnitude of the cost to the government and the people, the interest rate paid on the trust accounts by the commercial banks were bellow 1 %, while the cbb's were placed at 5 % and higher, and only this year it has come down to 4 %. the amounts were very large, at the peak the trust accounts reached close to k4. 6 billion and the cbb's issued were k4 billion. every one of us can see how costly this was to the government and the people of papua new guinea. the third problem was that most of the trust accounts were aimed to be spent on development projects and there was and still is very limited implementation capacity, that result in non - efficient use of the funds and in some cases some of the funds were misused. the fourth and last issue i want to point out is the trust accounts offered a stabilization potential. they could be drawn down when the revenues decline. when it came to the test in the sharp decline of the commodity prices in 2008, it did not work. the government incurred a relatively large deficit of k 479 million, which as expected has had an inflationary impact that resulted in a two digit level inflation of 11. 2 %. the generally accepted paradigm by the government and the bank of papua new guinea is that, a very responsible fiscal management, which aims at a balanced budget, or at the worst case at a very low deficit, and a complementary monetary management with the main objective of price stability, defined as low inflation levels, which is a necessary condition for a long term, sustainable economic growth. if properly done, this can benefit the