##liplier - accelerator process. that is, an unexpected demand shock results in higher output and income, which, in turn, further boosts consumption and investment, reinforcing the effect of the errors on income and output. this is also part of the story of faster - than - expected output growth in 1997. but unexpected strength in aggregate demand is usually damped by more restrictive financial conditions, by some combination of monetary tightening and movements in longer - term interest rates. while a ¼ percentage point increase in the funds rate was implemented last march, financial conditions, more broadly, became increasingly supportive rather than more restrictive as the year progressed. real long - term interest rates, measured using surveys of inflation expectations, were steady to declining over the year, likely reflecting a smaller - than - anticipated budget deficit and an unwinding of expectations of tighter monetary policy. nominal rates matter, too, especially for housing, and longer - term nominal rates fell, due to the lower - than - expected inflation. equity prices unexpectedly soared, reinforcing the strength of both consumption and investment. so, instead of financial conditions dampening the demand shocks, as would normally be the case, more supportive financial conditions actually reinforced them. this is another piece in the puzzle. financial conditions remained supportive partly because the better - than - expected inflation outcome kept the fed from raising the federal funds rate, except for the single ¼ percentage point move in march. the decline in inflation, in turn, reflected reinforcing effects of a sharp decline in energy prices, a significant slowing in the increase in food prices, and a further decline in core inflation. overall cpi inflation was widely expected to slow because of a projected reversal of the sharp rise in oil prices over 1996. about one percentage point of the slowing of overall cpi inflation over 1997 was, in fact, due to the relative movements of food and energy prices over 1996 and 1997. this was a somewhat sharper effect than was anticipated at the beginning of the year and accounts for a small part of the forecast error on inflation. but the greater surprise was the decline in core inflation. a major source of this error was the unexpected further appreciation of the dollar and thus the renewed decline in import prices. the dollar had been expected by many to stabilize in 1997. instead, it appreciated sharply, by 11½ % based on the multi - lateral trade weighted index of other g - 10 currencies and by even more for broader indexes that include other major trading partners. continuing sharp declines

is critical that this newly injected liquidity be reduced again, in order to prevent an undesirable rise in inflation. scaling back liquidity, on the other hand, reduces the balance sheet total. given that the initiative is calling for gold to make up at least 20 % of the snb ’ s assets, a temporary liquidity increase would require gold holdings to be increased, too. in a post - crisis scenario, the excess gold would have to be retained on the balance sheet for ever due to the sales ban, and the snb would have to sell some of its foreign exchange reserves in order to effect a liquidity reduction. consequently, this prescription regarding the percentage of gold to be held, as well as the ban on sales, could ultimately lead to a situation in which the snb ’ s assets consist almost entirely of gold, but in which it is unable to perform balance sheet reductions required for monetary policy. in the long term, the passing of the gold initiative could therefore threaten price stability in switzerland. even with regard to security, the demands made by the backers of the initiative are misguided. insisting that the snb hold a higher proportion of gold on its balance sheet even though this gold cannot be deployed in an emergency is counterintuitive. in such circumstances, the snb ’ s gold would lose its significance as a currency reserve ; the notion that gold should be held even though it cannot be utilised quickly and freely runs counter to the very raison d ’ etre of currency reserves. we may even go so far as to say that gold which cannot be sold in a crisis no longer meets the definition of a reserve and thus offers no security at all. while the gold initiative ’ s third demand – that all of the snb ’ s gold holdings should be stored in switzerland – may be unproblematic in monetary policy terms, this too runs counter to the notion of security. gold is stored in multiple locations for reasons of risk diversification, in other words to improve security. the lion ’ s share of the snb ’ s gold reserves ( approximately 70 % ) is already stored in switzerland and an appropriate regional diversification serves to enhance the snb ’ s market access. concluding remarks please allow me to make a few closing remarks. managing switzerland ’ s substantial foreign exchange reserves in the country ’ s best interest remains our key investment policy challenge. new markets are playing an important role here. i have discussed the growing significance of asia and