if we recognise that markets do not always work perfectly, the following considerations must be inferred. first, it is not correct to subject only to the judgement of the market the suitability of the economic policy of a country, especially when this may involve highly destabilising effects for millions of people. i am not arguing that we should ignore market valuations, but we should be aware of the conditions in which such assessments are made ; these valuations cannot be the sole reference parameter, at least for those who are responsible for the public good. second, faced with the imperfections of the market, intervention by an economic policy authority may be justified. this applies particularly when markets are subject to high for example, c. nelson and a. siegel, 1987, parsimonious modelling of yield curve, journal of business. bis central bankers ’ speeches uncertainty and the time horizon of market participants is getting shorter, making necessary a participant with a longer time horizon to counter market malfunctions. even milton friedman recognised that in some circumstances the intervention of a public authority such as a central bank could be necessary to stabilise financial markets. 4 the monetary authority tends to intervene to a limited extent in issues related to liquidity and the smooth functioning of markets, which influence the effectiveness of monetary policy itself. given the importance of the government securities market in the financial system, its malfunctioning has a direct impact on the monetary policy transmission mechanism. this is done through three main channels : i ) the influence that the interest rates on public debt have on the rates that banks pay on their liabilities, and then pass on to households and firms, ii ) the effect of changes in the prices of government securities on the accounts of financial intermediaries, which in turn affects the ability of banks to provide credit to the real economy, iii ) the ability to use government securities as collateral for refinancing in the money market or from the central bank, which influences the liquidity of the banking system. here i would like to refer to the second factor relating to the importance of the government securities market to the good functioning of monetary policy. in any basic textbook of macroeconomics – from burda and wyplosz to mankiw – the operations of the central bank aimed at regulating the amount of liquidity in the system – the so - called open market operations – are essentially characterised by purchases and sales of government securities or the re - financing of the banking system against collateral

curtailed price increases on their own products to avoid losing sales. this all suggests that in an economy with well - anchored inflation expectations, relative prices adjust quickly to maintain the overall rate near target ; with domestic price inflation, for example, moving in the opposite direction to import price inflation. in effect, where the target is credible, the market adjustments to relative prices will do most of our work. that is another reason for paying very close attention to inflation expectations. the mpc has been successful over the years in maintaining inflation expectations at a rate broadly consistent with the inflation target. anchoring expectations in this way is important because it prevents the wage - price spirals that were a key part of the inflation process in the past. if wage and price setters believed that inflation was going to rise above the target, then they would make some allowance for this in setting 28 - 30, 2003. the bank for international settlements has also emphasised the ‘ increasing global character of the inflation process ’, see bis annual report 2006. current wages and prices. that would add to current inflationary pressure, requiring higher interest rates to control it. while there was some evidence of a pickup in the general public ’ s inflation expectations at the beginning of the year, probably in response to higher gas prices, they have fallen back a little since then and do not yet appear to have had any effect on actual wages or prices. conclusion to sum up, by delivering the inflation target the mpc seeks to produce a platform of stability. that doesn ’ t produce a quiet life for businesses – on the contrary it can make the pace of change quicker because it makes the underlying business imperatives clearer. in recent years, we have been helped in keeping inflation low and stable by the integration of new economies into the world market and the disinflationary pressure that has produced. as a result of that stability, the market and the public now expect inflation to remain around target and that appears to have helped to damp the impact of the recent oil price hikes on the overall inflation rate ; the total impact has been modest and there are no signs yet of spillovers into wages and prices. we do not know yet whether the benign international context will continue or what other shocks may occur. we are seeing renewed rises in energy prices this year which have helped push inflation back above target. our role is to continue to assess the situation as it develops, monitoring economic data, financial markets, and listening to our regional agents and their business contacts