##flows been used effectively, the imbalances need not have led to financial ruin. in the united states and other countries with current account deficits, however, borrowing too often supported excessive spending on housing and consumption, rather than financing productive investment. most important, declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased use of opaque financial products, and more - general inadequacies in risk management by private financial institutions helped foster a dangerous and unsustainable credit boom. with the financial system evolving rapidly, supervisors and these remarks solely reflect my own views and not necessarily those of any other member of the federal open market committee. i appreciate the assistance of trevor reeve of the board ’ s staff in the preparation of these remarks. for a further discussion of this distinction, see edwin m. truman ( 2010 ), “ the international monetary system and global imbalances ” ( washington : peterson institute for international economics, january ). bis central bankers ’ speeches regulators, both in the united states and in many other countries, failed to recognize and address the mounting vulnerabilities. in short, these failures rooted in the financial system interacted with weaknesses in the global monetary system to create stresses and instabilities that eventually triggered – and amplified – the recent financial crisis and subsequent recession. other economic crises can similarly be traced to the interaction of weaknesses in the global monetary and financial systems. for example, the asian financial crisis of the late 1990s was rooted in failures to prudently allocate capital to productive investments – failures of financial intermediation. but these problems were made worse by characteristics of the international monetary system, as heavily managed exchange rates encouraged excessive foreign currency borrowing. the collapse of the thai baht in mid - 1997, which marked the beginning of the crisis, resulted in substantial balance sheet losses – particularly for that country ’ s banks – and triggered a widespread reappraisal of risk in the entire region. as investors lost confidence, capital fled these economies, precipitating a severe downturn. as in the recent experience of the united states, better management of domestic financial systems in the emerging asian economies would have greatly limited, if not prevented, the financial vulnerabilities that ultimately resulted in the crisis, but policies regarding exchange rate regimes and capital flows were also an important part of the story. the conclusion i draw from these and other financial crises is that we must strengthen both the financial system and the monetary system to create

real gdp declined by 0. 1 %, quarter on quarter, in the third quarter of 2012, following a contraction of 0. 2 % in the second quarter. available data continue to signal further weakness in activity in the fourth quarter and at the beginning of 2013. this weakness reflects the adverse impact of low consumer and investor sentiment on domestic expenditure, as well as subdued foreign demand. however, financial market sentiment has improved and the latest survey indicators confirm earlier evidence of a stabilisation in business and consumer confidence, albeit at low levels. later in 2013 a gradual recovery should start, with domestic demand being supported by our accommodative monetary policy stance, the improvement in financial market confidence and reduced fragmentation, and export growth benefiting from a strengthening of global demand. the risks surrounding the economic outlook for the euro area continue to be on the downside. they relate to the possibility of weaker than expected domestic demand and exports, slow implementation of structural reforms in the euro area, as well as geopolitical issues and imbalances in major industrialised countries which could both have an impact on developments in global commodities and financial markets. these factors have the potential to dampen the ongoing improvement in confidence and thereby delay the recovery. bis central bankers ’ speeches according to eurostat ’ s flash estimate, euro area annual hicp inflation was 2. 0 % in january 2013, down from 2. 2 % in november and december and from 2. 5 % in october. on the basis of current futures prices for oil, inflation rates are expected to decline further to below 2 % in the coming months. over the policy - relevant horizon, in an environment of weak economic activity in the euro area and well - anchored long - term inflation expectations, underlying price pressures should remain contained. risks to the outlook for price developments continue to be seen as broadly balanced over the medium term, with upside risks relating to higher administered prices and indirect taxes, as well as higher oil prices, and downside risks stemming from weaker economic activity and, more recently, the appreciation of the euro exchange rate. turning to the monetary analysis, the underlying pace of monetary expansion continues to be subdued. the annual growth rate of m3 decreased to 3. 3 % in december 2012, from 3. 8 % in november. shifts from overnight deposits to short - term time deposits led to a decrease in the annual rate of growth of m1, which declined to 6. 2 % in december, from 6. 7 % in november, and outflow