, a rise in the expected excess returns implies a lower demand for money. in the course of the last 20 years, the globalisation of financial markets owing to the reduction of transaction costs and the enhancement of information flows has increased the share of global wealth invested outside investors ’ home jurisdictions. the models of tobin and markowitz have become, therefore, much more complicated when extending the analysis to the global environment. portfolio theory suggested that assets should be considered imperfect substitutes for each other, with the differences in their expected yields reflecting their marginal risks regardless of the economy being open or closed. however, the representative agent model is no longer applicable in the case of an open economy, as the presence of international capital flows requires either asymmetric information or heterogeneous belief among various agents. this makes the theoretical and empirical efforts to search for policy solutions a very complicated business. in an open economy setting, for given risks, a rise in expected excess returns does not necessarily imply a lower demand for money. domestic assets may be purchased by foreign investors generating net portfolio inflows, which would raise domestic money growth. it is also true, however, that money and credit growth could trigger international portfolio flows. specifically, two mechanisms can be identified through which liquidity affects international portfolio flows. first, strong money and credit growth in one country may induce capital outflows to foreign asset markets, thereby exerting upward pressure on prices for financial and real assets abroad. second : at the same time, ample liquidity conditions in the domestic economy may fuel strong economic growth and be accompanied by higher asset prices, thereby inducing foreign capital inflows. the current magnitude of the stock of global liquidity and global savings is such that the asset prices and money growth of large economic areas, including the euro area, can be affected by them. in the same vein, large net capital inflows, as well as their sudden reversals, may also have important real consequences for large economies as they can systematically influence domestic monetary developments with potential implications for monetary policy. evidence from the euro area shows that international portfolio flows have played an increasingly important role as a driving force for monetary dynamics. as you are aware, the ecb ’ s monetary policy strategy attributes a prominent role to the analysis of monetary aggregates and their counterparts in the assessment of risks to price stability over the medium to longer term. the growing size of international capital flows associated with globalisation of financial markets has made the analysis of monetary aggregates, for the

jurgen stark : the external dimension of monetary analysis dinner speech by mr jurgen stark, member of the executive board of the european central bank, on the occasion of the ecb workshop on “ the external dimension of monetary analysis ”, frankfurt am main, 12 december 2007. * * * the role of monetary analysis in the monetary policy process remains a topic of utmost importance to all central banks, whatever the strategy they pursue. it is pertinent to adopt a new perspective on monetary analysis, focusing on the impact of the global environment on monetary developments and how they should be assessed. given the recent financial turmoil that has affected global markets, in part via international capital flows and global financial linkages, it is important to link monetary analysis to international developments. let me come straight to the key substantive issues. in essence, i see three main topics for discussion : first : how can we assess global liquidity and what are its implications for consumer, commodity and asset prices? second : what evidence is there of possible links between global monetary liquidity, international portfolio flows and domestic monetary growth? third : in the context of the influences exerted by globalisation and, specifically, cross - border capital flows, what are the implications for monetary policy? in my remarks, i will address each of these issues in turn. first of all, when talking about liquidity, it is important to clarify that, in the field of central banking and monetary policy, there are at least four distinct definitions of liquidity – each with its own implications for policy - making. the first relates to “ central bank liquidity ”, which is provided to the money market in order to steer short - term interest rates. the second refers to the general “ monetary policy stance ”, as summarised by the level of policy interest rates. the third relates to “ financial market ” liquidity, which is defined as the ease with which large volumes of financial securities can be traded, without affecting the market price. the fourth refers to “ monetary liquidity ”, which is defined in quantitative terms on the basis of monetary and financial aggregates. while all are important – indeed key – to monetary policy - making in the current environment of strong money and credit growth at the global level, i deem it necessary to say a few words on this last type of liquidity. i think you would agree that it is difficult to precisely measure global monetary liquidity. there seems to be no universally accepted definition of it among economists. several measures have been