, the cost of intraday credit is limited to the opportunity cost of depositing the appropriate level of collateral. therefore, central banks are concerned with the robustness of payment systems and the financial positions of banks participating in the money market, in order to prevent systemic risk that could stem, for instance, from the potential “ domino effect ” if a participant fails to meet its settlement obligations. central banks are concerned also by financial stability from a monetary policy point of view. i would say that price stability can be regarded as the bedrock of financial stability, while financial stability is critical to the efficiency of monetary policy. let me elaborate further on these two points. first, why is price stability the backbone of financial stability? financial stability can be achieved on a sustainable basis if financial resources are not misallocated. past experience, as well as a large number of economic studies provide evidence that inflation brings about distortions in the allocation of resources. for instance, the calculation of returns is biased, due to the fact that the replacement cost of fixed assets is structurally underestimated. this may result in sub - optimal investment decisions, and over - optimistic credit risk assessment. conversely, in the case of deflation, the solvency of indebted companies may be jeopardized, as the value of cash flows decreases over time, while the face value of debt remains stable. second, why does financial stability matter for the efficiency of monetary policy? the efficiency of monetary policy relies on the effectiveness of the transmission channels of monetary policy. central banks have direct control over short - term interest rates only. the impact of monetary policy decisions on prices goes through various channels - acting directly on the anticipations of economic agents, influencing banking credit conditions, the exchange rate and other asset prices. uncertainty may arise when these channels do not act in a predictable way nor with relatively stable time lags. in this respect, financial instability may affect the transmission channels of monetary policy. for instance, large fluctuations in asset prices may modify the behaviour of agents by decreasing the level of confidence. such fluctuations can also expose bank portfolios to a higher risk of losses, inducing banks to compensate for these risks by restricting credit. let me stress that, although a price stability oriented monetary policy is conducive to financial stability over the long term, episodes of financial instability have been known to take place during periods of low inflation. price stability must be therefore regarded as a necessary but not sufficient condition. other parameters influence financial stability, among

risk profile, in order to bring back their own asset portfolios to levels of volatility matching their requirements. therefore listed companies will have an incentive to adjust their risk profile and avoid more hazardous - which may also be more innovative - investment projects. therefore, “ entrepeneurship ” may be curbed and the growth potential may be influenced adversely. another impact of volatility on financial management is related to recourse to hedging, namely derivative products. as i mentioned earlier, derivatives are a driving force behind mature financial markets, and their strong development in the last two decades is merely consequence of the benefits they have generated. more precisely, derivatives and related financial innovations have enabled companies to transfer the impact of interest rate and currency fluctuations to financial institutions or investors that were ready to manage it, whereby facilitating international trade or project financing. meanwhile, the pricing of derivatives is closely linked to volatility. as volatility is indeed difficult to predict, market practitioners have developed models, which are constantly being refined. over time, market participants, - especially banks, - have become more competent in managing risk, while being left that residual risks which are more complex and harder to control. these consequences would not be a major concern, if the episodes of excessive volatility were only accidental. peaks of volatility clearly reflect macroeconomic imbalances, as soon as market participants take into account the relevant information. this has been evidenced in studies reviewing factors behind currency crises in emerging countries. macro data - such as balance of payment or fiscal policy indicators - prove to be discriminant - leading indicators from this point of view. however, i cannot affirm that the resolution of market imbalances would result in a reduction of volatility to levels that prevailed before these imbalances were taken into account by market participants. in my view one should not underestimate the part played by technical factors in the persistence of volatility peaks. this persistence in volatility is fuelled by technical features that facilitate the build up of mimetic behaviours ( amplifying effects ), or that reinforce the links between the various market segments ( diffusion effects ). mimetic behaviour is of course by no means a new phenomenon on financial markets. however benchmarking, index management, and risk management techniques may have gradually reinforced this type of behaviour, as participants are under increasing pressure to follow their peers through matching the performance of a benchmark. there is